In their latest episode of the VALUE: After Hours Podcast, Mark Valdez, Jake Taylor, and Tobias Carlisle discuss:
- Becoming A Serial Acquirer Like Berkshire & Constellation
- What Makes Modern Day Conglomerates Great!
- Warren Buffett – Take The Dagger Off The Steering Wheel
- Investing Lessons From Earthworms
- Where Will Startups Turn To Now That SVB Is Gone?
- There’s Still Tons Of Dry Powder In VC Land
- Making Your First Acquisition
- Tiger Global vs SoftBank
- Every Company Can Be A Software Company
- Private Equity – Cut Your Flowers & Water Your Weeds
- The Explosion In Search Funds
- Venture Capital Is Jet Fuel
- Working With Andreessen Horowitz
You can find out more about the VALUE: After Hours Podcast here – VALUE: After Hours Podcast. You can also listen to the podcast on your favorite podcast platforms here:
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Full Transcript
Mark: [laughs]
Tobias: Preparing for livestream.
Mark: Oh, there you. All right.
Jake: Now, we got it.
Mark: I click that.
Jake: [chuckles]
Tobias: This is Value: After Hours. I’m Tobias Carlisle, joined as always by my cohost, Jake Taylor. Special guest today is Mark Valdez. He’s the Founder, prime mover, head cheese [Jake laughs] at Eads Bridge Holdings. It’s like it sounds, an investment holding company. We’re going to talk to him about what that means in just a moment. How are you, Mark? Welcome to the show.
Mark: I’m great. Thanks for having me. Humbled to be here.
Tobias: JT, good to see you, as always. Where’d you come in from? What’s in your background there?
Jake: This is Chase Field in Phoenix, Arizona, where I went to a couple of games last week. I was in town for my son’s weeklong baseball tournament. I can confirm that there are many large 15-year-old boys and 16-year-old boys-
[laughter]Jake: -in the United States playing baseball. You wouldn’t believe. Some of these guys look like they’re on their third marriage and-
[laughter]Jake: -have a mortgage. [laughs]
Mark: Anybody hitting 90 miles an hour yet, or not quite?
Jake: I didn’t see 90 this tournament, but probably another year or two, some of these guys will be there.
Mark: Wow, that’s wild.
Jake: Yeah.
Tobias: Let me just give a quick shoutout to everybody, and then we’ll dive into what Mark’s up to. Dubai, Samson Narokobi, first in the house. How are you, Samson? Good to see you again. Santo Domingo, Dominican Republic. Nashville. Riyadh. Moncton, Canada. Scotland. Bendigo. Victoria. Toronto. Sofa. Durham. Roseville. Cracow. Durham. That’s a good spread. Where are you based, Mark?
Mark: I’m in Menlo Park, California. Originally from St. Louis, Missouri. So, the Eads Bridge is a real bridge back home. And so, try to keep it close to home and good shoutout to where I’m from.
Tobias: We’re all in California for this one. You’re in California, JT?
Jake: Yeah, I’m back though.
Tobias: Did you make it back?
Jake: Yeah, it’s good to be home. Sleep in my own bed.
Mark: [laughs]
Jake: So, Mark and I originally met in 2019, I think, sitting on the couch at Chris Bloomstran’s house. I came into town, and Mark was already there, and we hung out, and went and had an amazing dinner, and then went to Capital Camp together back in 2019, and stayed in touch ever since. Actually, Mark’s been really helpful early on when I had some VC related questions about Journalytic, because I didn’t know anything at all, and I needed someone to help me understand some things. So, I’ve been eternally grateful for that.
Tobias: What do people not know that they need to know when they’re getting VC? What do most people not know? What do they understand?
Jake: Oh, God.
Mark: [laughs]
Jake: I’m going to let Mark– [crosstalk]
Mark: Where to start? Yeah.
Tobias: I’ll just hang the headphones up. I’ll be back in an hour.
Jake: Yeah, the show is only an hour long.
Mark: [laughs] Yeah, I spent about 10 years in venture capital, and left VC to start Eads Bridge Holdings. [crosstalk]
Jake: When you say that, Mark, what were you actually doing? Because I was always very impressed by this, your chief of staff role, right?
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Working With Andreessen Horowitz
Mark: Yeah. So, I had a few different roles. Ended up falling backwards into venture capital, and joined Andreessen Horowitz in the very early days in 2009 when they were first launching the firm. So, I was one of the first employees. It was very much a bare metal shop at the time. We were just getting the thing off the ground and running. And ended up going to business school, and then ended up back at Andreessen working for Mark as his chief of staff for about two and a half years.
I did not have a technology background, and had never done early-stage investing. Prior to this, I had spent three and a half years at Stanford’s endowment, very traditional asset management role. Had done the CFA, all that kind of fun stuff. And so, this was very much the opportunity for me to drink from the fire hose. Learn from Mark about technology, early-stage venture investing, as well as building a new platform from scratch. Andreessen Horowitz was very much a unique beast at that point in time, a disruptive force within the ecosystem. And so, I had a front row seat into how Mark and Ben thought about building the firm from a strategic perspective.
Yeah, this kicked me down the venture career path, which I had been on for 10 years or so. Always a part of building and launching new platforms from scratch. I really enjoyed the strategic aspect of that, in addition to the day to day of meeting entrepreneurs and investing in early-stage companies. Most recently, I was at a firm called Playground Global. We were a little bit different. In that, we were focused mostly on deep tech, so AI, robotics, biotech, quantum computing, fun things like that. Long story short is, we wouldn’t shy away from technical risk, assuming there was a massive market opportunity on the other side of that. My job was to help build out the venture function, the team strategy, the deal flow, run diligence processes, and lead deals, and sit on boards myself.
Yeah, and then as I mentioned, ended up leaving venture to pursue building Eads Bridge Holdings. We can get further into this, but the quick story there was that, two observations sort of led me down this path. Number one, really believed that the risk return profile in venture had started to change pretty dramatically over the 10 years that I was in it. It’s always a bit of a momentum game, but this was the era of SoftBank and Masa.
Jake: Yeah. How bad did it get?
Mark: It got pretty bad.
Jake: [laughs]
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Every Company Can Be A Software Company
Mark: Yeah. We could definitely go off on a tangent on this for a while too. There’s parts of that that were valuable and important for the ecosystem, and then parts of it that really skewed the worst behavior in many ways. But I was a big believer in what was happening from the technology trends. And so, this was really the other observation, which was, given how much the software ecosystem has evolved over the last 30 years, 40 years, the opportunity really does exist now for every company to be a software company. You don’t need to hire software engineers. You don’t need to create build new software from scratch. It’s really about how you leverage software for acquiring customers, delivering your value proposition, enabling data driven decision making. The tool set for that exists off the shelf. You don’t need to reinvent the wheel to go do that.
The hard part is for traditional non-tech businesses that are outside of that ecosystem, how do you cut through all the noise, and the jargon, and the BS, and figure out what are the products and services that are going to actually help drive my business forward? It turns out that’s just easier said than done, given the pace of innovation and how fast things move in Silicon Valley. If you’re behind, it’s hard to catch up. And so, thesis for Eads Bridge Holdings was then to how do we bridge that gap, and really create the mechanism for these traditional businesses to participate in the tech revolution as well.
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Venture Capital Is Jet Fuel
So, coming back full circle on what do most people not really understand or realize about early-stage venture, I think the big thing, guys, is really that venture capital is jet fuel. It really only makes sense for a certain type of company with the blitz scaling, the growth mentality, and how do you build category defining independent companies that could be IPO. That’s not for everyone. Unfortunately, there’s not a lot of other mechanisms for early-stage companies to receive financing. But you need to ensure that it’s right for you and for your company to want to go down that path. I’ve seen this many times where you can end up destroying more value than you create by trying to be on these venture growth curves, and ultimately achieve that category defining status. It’s great when it works and it works really well when it does, but like I said, it’s not for every company.
Jake: It makes sense. Not as many unicorns as there are dollars chasing unicorns.
Mark: Yeah, there’s so much money that has poured in the ecosystem. I think what also makes that really hard is, you’ve now got venture funds that are investing out of billion dollar plus size funds. Guess what? A billion-dollar outcome. When you own maybe 20% of that business, not good enough for you if you raised a billion-dollar fund. Like, how many of those do you got to get to have a 3X to 5X net for your LPs, which is ultimately what you want to be able to deliver. And so, that just skews this whole mentality even further. It’s a funny ecosystem. You deal with the fear of omission, not the fear of commission. You don’t want to miss the big winners. But if you lose money, people expect that, right? Taken to its furthest extent, it can lead to a very perverse decision-making process. That’s a really hard thing to balance. I think a lot of venture capitalists struggle with, but that’s in many ways, I think, what separates the good from the great in that industry.
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Tobias: How do you describe Eads Bridge Holdings? Yeah, let’s just start there. How do you describe it?
Jake: [laughs]
Mark: Yeah. The really basic level, as we talk about it, is we’re a holding company that acquires and tech enables traditional businesses. We’re focused on the lower middle market. And so, we’re generally looking at owner operated businesses. They’ve been around for 15 years, 20 years. Tech wasn’t core to the business, nor did it need to be when they first got started. We would obviously argue over the next 20 years, it’s probably going to matter a hell of a lot. And so, our job is to really provide the tool set, the resources, the strategy around how technology can be impactful, make a difference for those businesses, and ultimately lead to long-term competitive differentiation, and viability and success. [crosstalk]
Jake: Are you looking more product or services when it comes to that, when it’s traditional businesses? Does it matter?
Mark: It doesn’t matter exactly, but I would say we tend to skew more towards services businesses. But we do keep a pretty wide top of the funnel. I think this is one of the things that I’ve carried over a little bit from my time in venture, which is, let’s not be overly prescriptive about this. Certainly, we have criteria. Certainly, there are key things that we want to look out for. But there are so many companies at this lower middle market stage. I’m talking like $1 million to $5 million of EBITDA. There’s thousands of them, and they’re covering all sorts of industries and products like you just don’t even think about. So, we want to come up with a prepared mind, but let’s not have all these preconceived notions. Let’s meet great entrepreneurs that have, in many cases, bootstrapped these businesses from scratch.
That’s what gets me really excited many times is, in Silicon Valley, we put the entrepreneurs on these pedestals. But we also provide them with massive amounts of capital, and resources, and platforms at their disposal. And then you go out and doing what we’re doing now, and you’re talking to these business owners, and what they build without the capital, fully bootstrapped. Blood, sweat and tears, right? It’s just like their own willpower that has built these companies to this level where they’re profitable, they’re sustainable, they understand their customers, their industries far better than we would. That’s really exciting to me. And now, for us at EBH, we bring to bear the technology tools and insights, pair that with an entrepreneur who’s incredible at what they do, and hopefully we’re creating an inflection point for this business, and we’re off to the races. And so, that’s what really gets us excited.
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The Explosion In Search Funds
Tobias: The idea of doing lots of acquisitions, for a while it was search funds. Search funds are still around, I think.
Mark: Oh, yeah.
Tobias: That idea where you raise a little bit of money, basically an MBA, come out and do one acquisition of an older company that’s well established, so you’re taking away the business risk, and you’re helping it transition to the next generation. That seems to be a simpler way of doing it than– or maybe starting a little business. How did you go from being a VC, essentially an employee, to being the prime mover? How did you raise the capital or did you use your own capital? How did you make your first acquisition? Because I think that’s where a lot of people who are interested in doing this stuff will be very interested in that transition process.
Mark: Yeah, there’s no doubt that the search ecosystem has exploded since I was in business school 10 plus years ago.
Tobias: Were you at Stanford?
Mark: I went to GSB. Yeah.
Tobias: [unintelligible [00:13:55] at Stanford, isn’t he? [crosstalk]
Mark: That’s right. Mm-hmm. Yeah.
Tobias: He’s the gentleman– or he popularized the idea, at least-
Mark: That’s right.
Tobias: -[unintelligible [00:14:04], right?
Mark: That’s right. Yeah. I graduated in 2011. I think there was a handful of classmates that went down the search path. Now they have a massive search fund club that has dozens of people that are members. It’s not just a Harvard and Stanford thing, it’s at all probably the top 10 or 12 MBA programs. And so, it’s really exploded. I actually liken it to venture, but probably 25 years ago. It’s starting to institutionalize. There’s more money that’s coming in, because they’ve seen how great the outcomes are. It’s super compelling. No doubt about it.
There’s also a set of folks, sort of investors from the search ecosystem that have started to carry over into what people call either long-term hold or this holding company model. I came at it from a very different perspective, because I was in venture. I was not paying attention at all to what was happening in the search fund ecosystem. My mindset around this was totally different in thinking about where the gaps were in the investing landscape. And so, one of the observations was that—
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Private Equity – Cut Your Flowers & Water Your Weeds
What’s so compelling, I think, in many ways from my perspective around venture capital is, you generally operate with a very long-term mindset. You’re going to let your winners run as long as possible, because it’s a grand slam business. That’s where you make all your money is on your winners. Counter that with private equity, which tends to be a little bit more of cut your flowers and water your weeds. As soon as you got a good company, let’s go sell that.
Tobias: Flip it.
Mark: Put money back into our LP’s pockets, raise the next fund, and keep going. Nothing wrong with that, right? I’ve got a lot of friends in private equity. They all do quite well. They’re super smart investors. But that wasn’t what got me excited. I was starting to think about and having been on the LP side of the business, how do you create a model with much longer-term aligned incentives between investors and management, the GP and the LP dynamic? I had seen, during my time at Stanford, many cases where that had gone wrong. And had always said that if I ever go out and do my own thing, I’m going to do it differently.
To me, the ultimate aligned model for this was as a company. And so, if you think about what we’re doing as a holding company, there is no fund. There’s no fund franchise. We’re not incentivized to go raise the next fund, raise more funds, bigger funds to create the management fee stream where we profit at the expense of LPs. We’re just trying to grow equity value at the holding company. As we do that, and that grows and compounds everybody’s benefiting in that concurrently. [crosstalk]
Jake: How does new money–? If it comes in, do you issue equity in the company for the new–? [crosstalk]
Mark: We would issue it at the holdco level, because we always want to stay aligned there versus at individual port co levels. Yeah, you could think about it as a sequential fundraising path just as you would for any VC like deal, series A, series B. And so, that’s the path we had started down, which was, in my mind again, we’re not a fund. If we’re not a fund, we’re a company. If we’re a company, why can’t we finance ourselves like one? Let’s go raise seed capital, bring on the initial team, start building internal infrastructure, the deal pipeline, and then as we start to prove this out, we’ve got deals ready to go that we go raise additional capital at that point in time.
But the whole goal for us was to how do we build something that where we could take EBH public at some point down the road, and have that be the ultimate liquidity event for investors. So, it’s not that we’re trying to lock up capital forever. You’re never going to see your money back. That’s not the idea. But through the holding company structure, you incentivize this reinvestment model, compounding cash flow, creating equity value at the holdco level, and then potentially taking it public. The other piece of this– [crosstalk]
Jake: Next time, there’s the next bubble, you can take it public.
Mark: That’s right.
[laughter]Mark: Yeah, exactly. But the other piece of this was, going back to the private equity dynamic, look, people are smart. They recognize that technology can have meaningful impacts on these businesses, and a lot of private equity firms have hired tech operating partners. Before I started, I went out and met almost all of these guys. They’re smart and sophisticated from a technology perspective, but they tend to be hamstrung by the traditional private equity model. So, their job is like quick hit operational improvements, help service the debt, put lipstick on the pig, we’re going to shove this thing back out the door again. That to me signals that there’s a lot of opportunity being left on the table.
If you start to take that longer-term approach, a little bit of that VC mindset, how do you let your winners run, and opportunities where software can play a much more meaningful driver of long-term outcomes for these businesses, you would do all sorts of different things that the private equity guys wouldn’t do because it would fall outside of their whole period. And that’s going to benefit the next buyer, not us. So, why would we ever do that? That to me signaled there was an opportunity to flip the model, create a new value proposition for business owners which is to say, “Hey look, this is not lever, strip and flip. We’re here to preserve the legacy of what you’ve built, further enhance it with this tech enablement strategy, and provide you new resources, new capabilities you’ve never had before.” That tends to get people pretty fired up.
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Making Your First Acquisition
Jake: Do you find that there’s more value creation on the revenue side or on the cost saving sides of technology?
Mark: I think if you’re doing it right, it’s both. That changes over time too. Because there really can be quick and operational improvements where you’re like, “Oh, goodness, we’re sending physical checks. We should do direct deposit. We should run that through software system and have that run seamlessly.” And so, there’s things like that where you can make really quick operational improvements. But we really think about this as how you construct the business engine of a company. And if you start to think about what’s the flywheel of the business, how does software help push on the levers of the flywheel to make it spin a little bit faster, all of a sudden, things that are operational improvements can then bleed into creating a better value proposition, lower prices, the Amazon flywheel model. Over time, that leads to significant growth and differentiation.
So, through APIs, you can take what were once siloed functional applications, tie them together to create this business engine through software, and that’s what gives you operational efficiencies, but also points of differentiation which we think bleed into your value proposition and future growth.
Tobias: When you’re leaving your previous firm and you’re embarking on this new idea, are you outside funded? Did you raise VC to do it? Did you have an acquisition?
Jake: The irony.
Mark: Yeah, exactly. Well, it turns out, no, I did not raise traditional venture capital. Again, it goes back to what we were talking about before being jet fuel. Ultimately, I think of the outcome for what we’re building at EBH to be a venture scale outcome. I wouldn’t have gone down this path, if I didn’t believe we couldn’t build a multibillion-dollar company. I would have just stayed my cushy VC gig. We’re definitely a different beast. We’re not hiring massive amounts of software engineers and building new software from scratch. We have a very different business model with acquiring cash flowing businesses.
I didn’t want to try to be on this venture growth curve in order to justify the next round of capital, and have that be of the sequential fundraising path. So, we’ve put together more of a collection of high net worths family offices, smaller institutional investors that come from technology, private equity investment management fund of funds world that buy into the vision of what we’re building, believe in that long-term compounding model, and have different networks and insights and experiences themselves that they bring to bear for EBH. And so, we’re a unique thing. We don’t fall neatly into a bucket. We’re bringing together the best of technology, the best of lower middle market, MNA, in addition to company building, and culture, and all the things that are ultimately going to make us successful.
I do have a company mindset around what we’re doing and the people that we hire. And ultimately, we say what we’re building is not for everyone deliberately from investors to team to the partner companies that we’re going to have. Hopefully, you buy into who we are and what we’re doing, and the long-term opportunity there. But if you’re looking to fit something neatly in an asset allocation bucket, we’re not it.
Tobias: So, did you raise capital with no acquisition target identified? You just said, this is the philosophy and we’re going to go–
Mark: That’s right.
Tobias: So, in doing that, how did you articulate to your investors how you are going to control risk? We’re not going to do one single acquisition or we are going to do one single acquisition and we’re going to bolt that– What’s that process like?
Mark: Yeah. Well, number one was starting with a very small amount of money and just saying, “Hey, look, we’re just going to raise small amount of seed capital just to get us started.” Then, yeah, we’re going to bring you that first deal and say, “We’ve got to find out–” [crosstalk]
Tobias: So, this is very search fund like. That’s basically search fund like.
Mark: That part of it absolutely was very search fund like, Toby. But the big difference is we’re not injecting ourselves as the CEO, and we want to continue to do this, rinse and repeat this model many times over.
Tobias: And the money comes in– from that first acquisition, the money went into the holding company-
Mark: That’s right.
Tobias: -to allow you to do the explicitly with the idea that you’re going to go and then identify other acquisitions- [
Mark: That’s right.
Tobias:
essentially by a CEO at that level.
Mark: That’s right. Yup, exactly. And so, the goal for us is to have two to three vertical platforms over time, each with its own tech enablement, playbook, M&A strategy, and management teams. We have to try to run these as decentralized as possible. There will be core platform components always at the holdco level, particularly around technology and how we think about instrumenting the holdco as a software company itself. We could get a little bit more into that talent, which I think is a really critical component, and then business development, where we’ll still drive the new acquisitions from the holdco level early on.
Tobias: So, when you say these are companies that are perhaps suffering or not fully realized, because they don’t have that technology component in there that think that they should have, so you negotiate with a vendor who’s on their way out. You have a CEO in mind who can step into that role, and they have a playbook that you want them to implement or you implement with them. How does that work?
Mark: Yeah. So, a couple of things there. Number one, technology is not a panacea. This isn’t going to save a failing company or a company that’s off the rails. So, we’re still looking for quality assets. We just believe that now the technology playbook can create an inflection point for them, critical points of differentiation, and long-term success. And then we’re also, particularly for a new platform, looking to partner with an existing CEO or management team. So, this is tricky, because this is what the search fund model is playing into right now, which is the silver tsunami. All these entrepreneurs who are reaching retirement age, and may or may not have somebody to hand the business off to. And so, a searcher can make that acquisition, insert themselves the CEO, and have that transition point.
For us, we really want to have the CEO in place. Over time, we might think about models where maybe we bring in a CEO particular to a new platform, but this just creates risk, and so as much as we can create that continuity we’d like. And so, for the first acquisition that we made, number one, the business owner is 38 years old. So, still has a lot of runway and was excited to have a partner to help him take the business to the next level. Number two, rolls equity. Obviously, takes chips off the table, takes care of the nest egg, rolls equity, and will look to take a larger second bite of the apple down the road. It’s just that liquidity wouldn’t come through us selling to a third party, it would be more about EBH acquiring those shares in time. But we’re aligned through that equity ownership. He understands his business, his team, his industry, his customers far better than we do. We bring to bear a lot of the people processes and systems, as well as the ultimate tech strategy for that company.
Jake: Makes sense, most if you can get a reputation as a preferred buyer similar to what Berkshire has been able to do-
Mark: Totally.
Tobias: [crosstalk] -get some interesting dynamics happening there, I bet.
Mark: For sure. That’s the dream.
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Becoming A Serial Acquirer Like Berkshire & Constellation
Tobias: What are your inspirations? Berkshire? What about something like Constellation or–?
Mark: 100%. Yeah, Constellation– [crosstalk]
Tobias: Because they have that same bolt onto the platform, essentially let the CEO of the platform run that. And then, they have many diverse platforms. Initially, software. Now, I understand it’s pretty broad. They’ll do anything.
Mark: That’s right. Yeah. There’s no doubt Constellation is a company we look to in many ways. I think one of the things that I love about Constellation is really the compensation model that they have. I think they’ve just create such tight alignment between management and investors in that way that I think– [crosstalk]
Tobias: What do they do?
Mark: I’ll forget the details, but it is essentially– When they pay their year-end bonuses, which are very metric driven bonuses, I think they might even use an ROIC metric to be the main component of that. But something like 75% of that bonus has to then be used to purchase shares on the open market. I don’t know, if they vest or something like that, but there’s some time component associated with it as well. And so, they’re not just blasting out stock-based compensation like Silicon Valley has popularized over the last 5 years to 10 years. Yeah. You as employees or management, like, you are owners, and you better think like an owner, because that’s where all your compensation is going to come from ultimately.
But then, Danaher is also a company that we really look to, the Danaher Business System. We really think about what we’re building at EBH, the tech enablement playbook, almost that Vista equity playbook. And so, yeah, those are all different flavors of things that companies and leaders that I look to as in many ways, I think went against the grain. What I love about Mark Leonard was he was a former venture capitalist himself. It’s incredible to see the company that he’s built.
Jake: Do you ever get your hands on the Vista, the folder? I’ve never seen it either. I’ve always been curious to see what the hell is in there. [laughs]
Mark: No.
Tobias: Not that he’s going to admit publicly on the– [crosstalk]
Mark: Yeah. [laughs]
Jake: Yeah, me either. [laughs]
Mark: I’ve heard a bit about it, and have known some people that have been through transactions with them in different aspects. Look, honestly, I’m sure there’s lots of interesting insights in there. I think the allure of it is what I find to be most compelling.
Jake: No real silver bullets, right?
Mark: I doubt it. Look, I think [unintelligible [00:31:44] did an amazing job with this in many ways. I think investment management, whatever asset class you’re in, you’re still building a product. You still have to market. I think marketing and narrative is a really important component of these businesses. I think what Vista did there is incredible on that front. I hope it’s real in terms of exactly how it is. But even if it’s not, it’s amazing. It’s awesome. [laughs]
Jake: Yeah, technology.
Mark: Yeah, exactly.
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What Makes Modern Day Conglomerates Great!
Tobias: What do you think distinguishes the Constellation, Danaher, Berkshire, Vista, like that modern day conglomerate or whatever it is? The conglomerate to 1960s that everybody was– for a while, that was super-hot in 1960s, and then after that they became– The whole point of the leverage buyout era was that they were buying those busted conglomerates, and rationalizing them, bringing them back down to their core components so they could focus rather than being distributed. Why do you think this has come back around that there’s this reconstruction of that old conglomerate idea?
Mark: It’s a great question. I don’t know if I have the best answer for it. My sense of it is from the original conglomerate days, they just got into so many unrelated businesses.
Tobias: That was the attraction. I know you were diversified. So, something was always working.
Mark: I guess so, yeah. But that, again, can lead to a very perverse decision-making process where you’re doing a bunch of different things that have no ROI, and ultimately aren’t to the benefit of shareholders. I think things got pretty fast and loose on that front.
Tobias: It became an EPS game. They figured out that you could buy a terrible business. But if you got it cheaply enough and it was accretive to EPS, and then you had enough gloss on top so it looked like you were doing– You had the Vista Business Systems or whatever it was that you– [crosstalk]
Jake: You issued shares at, call it, 30 times earnings to acquire a company that was selling for five times earnings, and you just kept doing that over and over again.
Mark: Yeah.
Tobias: How do you distinguish the ones who are doing that versus something else?
Mark: I think it tends to be really related to the business strategy.
Tobias: Tracking return.
Mark: Do they have a playbook, and is there a real platform component to what they do? I think Constellation, TransDigm, Danaher are all great examples of that. I’m sure I’m missing a few others. Roper is one that comes up a lot. I think you can even look at a business like Danaher, where it’s transitioned significantly from what it was in the early 1980s when the Rales brothers first started the business, and they were acquiring small manufacturing companies. Right now, it’s a massive life sciences tools business. It’s completely different. I’ve heard Mitchell say that, every 10 years or so, they had to reinvent themselves. And so, a lot of that comes down, I think, to the management team, their incentive structure, their motivation. Are they going to do the right thing for shareholders or are you going to play some sort of EPS game which might be fun for a bit, but ultimately comes home to roost in a way that’s– [crosstalk]
Jake: Yeah, you become GE.
Mark: Exactly. Yeah. I just think there’s few folks that have that mentality. I think one of the things that is a good thing and a bad thing right now is that the holding company model has started to become a little bit more popular. I think my list is something like 30 that have gotten started within the last three to five years. I think it’s great, because I think done well should be the right incentive model for management and investors in creating that alignment. But if done wrong, then I think it’s going to set it back.
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Warren Buffett – Take The Dagger Off The Steering Wheel
Tobias: It was funny that the conglomerates they said they had the wrong incentive model, because the managers weren’t incentivized. That was the whole pitch of the LBO guys that they would come in, “Hey, you’re going to be an owner and we’re going to put all this debt on,” so you’re focused on increasing the cash.
Jake: Put a dagger on the steering wheel.
Tobias: Which Buffett famously-
[laughter]Tobias: -called the dagger on the steering wheel.
Jake: Yeah.
Tobias: But then, Buffett solved that problem by making– He’s got that compensation plan for the managers of his distributed companies that they get charged a cost of capital and they get paid a bonus based on what they can return to the mothership. So, that does seem to be a better way of– That takes the dagger off the steering wheel, but it keeps the same pressure to focus on returns on invested capital rather than just expanding it into lower and lower margin opportunities.
Mark: Yup, exactly.
—
Investing Lessons From Earthworms
Tobias: JT, do you have any veggies for today?
Jake: Of course, I do. I wouldn’t want to–
Tobias: We do this Mark on the show. You can come in and you can enjoy all of the fun stuff, but you’ve got to eat Jake’s veggies first.
Mark: [laughs]
Tobias: We all learn something.
Jake: The animal ones are always some of the most popular, so I’ve been trying to lean a little bit more animal.
Mark: [laughs]
Tobias: Let’s tell Mark why the animal ones are the most popular. The sperm whale is the most popular one.
Mark: [laughs]
Jake: Yeah, did one on sperm whales at one point that apparently was very popular. But this one today is about earthworms. So, we’re going the opposite of sperm whales. The earthworms, they live in the ground, obviously, and they eat this wide variety of organic matter, plant material, whether it’s leaves, branches, whatever the hell is falling and decaying. But they also eat living protozoa, bacteria, fungi, lots of microorganisms. They have two little brains that are near their mouth. That’s interesting. I don’t know of any other animals that have two brains, necessarily.
They don’t have eyes, but they do have these specialized photosynthesis or photosensitive cells that run along their backs and their sides. But to make up for being blind, they’re very sensitive touch and mechanical vibration. They have gizzards, which is this little fold, basically, in your throat, like a turkey, where they grind up the food with the help of these stored little mineral particles that basically crunch it together with that, and then it mixes with enzymes to break it down.
At birth, they emerge basically tiny versions of themselves. They’re fully formed. They become full grown after about a year. And then the average lifespan in field conditions is about four to eight years, which is longer than I would have guessed, but in a garden, typically about two years. A lot of people know this already. It’s funny that they’re hermaphrodites, which means they both carry both male and female reproductive organs. When they’re mating, the two earthworms basically 69 each other, and they’ll exchange sperm and fertilize each other’s eggs.
Apparently, on the banks of the Mekong River in Southeast Asia, there’s some species of earthworms that grow up to 10ft long, which I’d love to see. That’s wild. So, they play this major role in the conversion of relatively large pieces of organic matter that get turned into rich hummus, which it’s called, which I find it funny that loamy dark dirt is called hummus. Is that why people– Hummus tastes like dirt, I don’t know. But it really radically improves the soil fertility. They’ll shred up a leaf, basically digest it, and then they mingle that with the earth, and their movements will aerate the soil, which will allow air and water to get down into deeper into the soil and mix it all up.
So, if you have a lot of earthworms, that’s an indicator of a very healthy soil. The population size of earthworms indicates the quality of the soil. As the larger, sorry, the fresh earthworm poop, which they call casts, C-A-S-T-S, is 5 times richer in nitrogen, 7 times richer in phosphates, 11 times richer in potassium, which are all important ingredients for plants to grow. In these rich conditions, an earthworm will produce 10 pounds of casts per year per worm, which is a shocking number, right?
Mark: Mm-hmm.
Jake: Rich farmland can have up to maybe even over 1.5 million worms per acre, meaning that the weight of the earthworms in the soil is most likely greater than the weight of the livestock that’s upon on the surface. It’s estimated there are about seven million earthworms for every human on earth. So, this is actually a pretty successful species. So, here’s where things get a little off the rails, and we’ll try to make some analogies from earthworms.
Tobias: This is the most fun part, where Jake has to bring this back to investing somehow.
Mark: [laughs]
Jake: Yeah.
Tobias: Land the plane, Jake.
Mark: [laughs]
Tobias: All right, let’s see what I can do. Actually, there is a firm called Worm Capital, and I have a friend that works there named Eric Markowitz. So, shoutout to Eric. But apparently, they picked that name because they say they dig a lot. They wanted to instantly set themselves apart from Wall Street, which I feel like the name Worm Capital does pretty well. Anyway, you often hear about these vulture funds. They buy the equity or the debt of some distressed company, and they’ll often deploy legal actions to try to– They’ll try to obtain a contracted payout that was existed before.
So, think of Elliot going after Argentina and seizing one of their navy ships. But there’s a lot of negativity around that style of investment, I think that they’re taking advantage of the situation or they’re predatory. I’m sure some of that is a fair criticism, but it seems to me, there’s a place in the financial ecosystem for firms that do worm work. They buy the companies that have become economic debris, fallen leaves, left for dead in a changing world, and they recycle them back into rich soil where new growth might be able to occur.
I would argue that if you don’t have someone doing that kind of dirty worm work of liquidation, you actually don’t have a very healthy economy. I find it a little weird that we actually put stigmas on those type of investors who are turning over the soil. So, yeah, I think it’s actually fairly noble work to be doing that. We need, I think, the worms of creative destruction to keep the entire ecosystem healthy.
So, next time you see a worm on the sidewalk that’s struggling, do a good deed and move it back into the grass so that it can get back to its important job of turning over the soil, and think of this segment when you do it.
Tobias: Bravo. Good job.
Mark: That was well done.
Tobias: You did it.
Mark: That was very well done. Yeah.
Jake: Thanks.
Mark: [laughs]
Tobias: To Jake’s point, there has been this explicit moratorium on foreclosures and housing and a more implicit, I guess, prevention of a lot of stuff going under, which a lot of people think was Japan’s problem following the 1980s that they had-
Jake: No worms.
Tobias: -all the cross holdings. Yeah, they never got broken down. Do you think that Silicon Valley Bank having stumbled and then a series of banks, has that created some condition in Silicon Valley and more broadly that maybe we see a few more failures, and the earthworms can go back to work? How’d you like that segue to that question?
Jake: Nailed it.
Tobias: JT, pay me. Pay that.
Jake: Pay the man.
—
Where Will Startups Turn To Now That SVB Is Gone?
Mark: I think what’s going to happen with Silicon Valley Bank and First Republic, the two big players that were here in the ecosystem, I think there’s certainly going to be impact to the ecosystem. I think it’s going to be less directly related to the success or maybe to the failure of any near-term companies. The big miss is that, they were incredible stewards of the ecosystem. It was just a no brainer that if you’re starting a company, you go to Silicon Valley Bank or First Republic to get set up, because they understand what it’s like to be a founder, what startups need, how do they support them and nurture them, and ultimately see them be successful. Early on, they’re not focused on making money off of you as a bank. It’s very relationship oriented.
We banked with Silicon Valley Bank ourselves for EBH, and obviously, there was some near-term impact there. We’ve actually been going through the process of moving our portfolio company, the bank that they’re at for different purposes. But we’re looking at one of the large banks now, and they nickel and dime you on everything. There’s bureaucracy every step of the way. It’s a pain in the ass. Like, you’re dealing with committees of people, not just like one relationship manager. There’s friction all along the way. Ultimately, these are not the things that are determinants of success.
So, you as a founder don’t want to be spending time on these things. That’s what Silicon Valley Bank and First Republic had done such a great job of greasing the wheels on is keeping the focus on the things that matter, and supporting entrepreneurs as they’re going off, and building these businesses. It’s a big loss Now, I think what’s happening more broadly within the ecosystem, there’s still a lot of pain to be had, and I think that’s a function of a lot of companies swallowing more capital than they really need. It also evaluations that were unsustainable. I think there’s still a path for a lot of that to play out.
I think the other interesting area that I’m keen to watch is, what’s going to happen on more of the emerging manager side of things, which over the last five years or so, there’s been an explosion of sub $100 million dollar seed in venture funds. LPs today are stuck to the gills with venture. The big firms have been raising bigger funds, so they’ve been allocating dollars there. The IPO market and M&A markets have basically been closed, so they’re still sitting on- [crosstalk]
Jake: Nowhere to put it. Yeah.
Mark: -nowhere to put it. You’ve got a lot of guys that are coming back to market trying to raise fund one or fund two or fund three with probably not a lot of distributions to show for, and it’s going to be a real struggle. What happens to those emerging managers? Do they become zombie funds? Is there an opportunity to hoover up GP stakes? I think that would be a fascinating thing, if that came about. A lot of folks that who got into that weren’t necessarily VCs or professional investors prior. Maybe entrepreneurs maybe had worked at Google or Facebook, some of the bigger tech companies made a bunch of money. [crosstalk]
Tobias: Is that how the Lowercase Capital–? I’m just forgetting his name. [crosstalk]
Mark: Oh, Chris Sacca.
Tobias: Yeah. Is that how he got–? [crosstalk]
Mark: Yeah.
Tobias: Was he buying up those stakes? Is that how he got started initially?
Mark: No. Well, I don’t believe that’s how he got started. He did start as emerging manager, like a small fund. But that was back when the seed and angel market was still developing, which wasn’t an institutional thing for a long time. Then Lowercase first round, I’m blanking. There’s a few others that really started to raise institutional capital around that segment of the market and were extremely successful. But that has just seen an explosion over the last 10 years. A lot of that’s not going to be sustainable.
—
There’s Still Tons Of Dry Powder In VC Land
Jake: What do you think some of these companies that have whatever burn rate and time left on the shot clock, where are they going to get future funding to keep the business going, if they’re not profitable and sometimes even pre-revenue?
Mark: Yeah, it’s going to be tricky. On the one hand, bad news is, yeah, maybe you raised too much capital at too high a valuation, and you’ve created a hurdle which is going to be really hard to jump over in terms of the business performance and progress you’ve made during that time frame. The good news is, there’s still tons of dry powder in VC land. Again, all these VC firms have raised massive funds, and the pace of investing has definitely slowed down. But you’re probably not going to get the same valuation, so you might have to stomach a down round, a reset of terms and price. That comes with a lot of pain. You might lose employees through that. How do you keep the team together? So, it’s going to be a challenge. No doubt about it.
I think we’re still in the early phases of that, because a lot of companies had raised really big rounds in 2020, 2021. You probably raised 18 months to 24 months’ worth of capital. You now have seen the writing on the wall, so a lot of people have cut burn. There’s been a ton of layoffs, so maybe you extended that runway another 6 months or 12 months. So, I think we still have a ways to go over the course of 2023, 2024– [crosstalk]
Jake: Before those real cliffs that come into play.
Mark: Yeah, exactly. So, maybe the business has caught up by that point, but some of these valuations that you’re seeing were just crazy, crazy. And so, hopefully, you have enough capital to get to a point where you’re self-sustaining, but I think it’s going to be hard in a lot of situations.
Jake: If you have to raise again, you’re over the barrel, pretty much.
Mark: It’s going to be tough. Look, the best companies will always have capital. They’ll always be able to continue to finance. The worst ones will either go out of business, maybe you can find an acqui-hire. It’s going to be the in-betweeners, where that’s going to be tricky. There’s not a lot of vulture capitalists within the ecosystem, but it might be an opportunity for somebody to come in with really creative terms, have the right relationships, and ultimately create a win-win type of scenario for entrepreneurs in the team as well as investors. But it’s not an easy task, that’s for sure.
—
Tiger Global vs SoftBank
Tobias: From the outside, I had this impression that SoftBank came in and threw a whole lot of money and sort of increased the valuations for everybody. And then, I saw a chart recently that it looks like they’ve basically round tripped on their investments. There’s basically no gain over that period of time. So, have they pulled back, and what has that impact had on the ecosystem?
Mark: Yeah, I haven’t been following it as closely now that I’m out of the world a little bit, but my sense of is they’ve pulled back pretty significantly. I think I even saw a headline the other day that they had more layoffs within the Vision Fund. The approach that Masa took, and you can actually contrast it with Tiger Global, which is fascinating, but– [crosstalk]
Jake: I’d like to hear that.
Mark: Masa’s approach was really like, “Hey, we got $100 billion, [chuckles] and here are the categories of things that I care about. So, let’s go create the market map of these verticals, figure out who the leaders are in the space, and we’re going to go give those leaders $100 million or $200 million check and basically, try to play kingmaker.” The reality is, that’s not how you create successful companies. At the end of the day, it definitely can create a near term shot in the arm. It definitely freaks out your competition.
But having more capital than somebody else doesn’t necessarily create long-term sustaining points of differentiation in a business model that ultimately returns more than what you invested into the company. That’s just not how it works. But that was the approach was like, “Let’s go king make all of these companies. We own them all.” I wouldn’t be surprised, at some point, he thought he could take the Vision Fund public as its own conglomerate. But generally speaking, when companies have too much capital, they go to spend it, they don’t spend it wisely, you don’t see a good ROI there. It tends to devolve pretty quickly.
Contrast that with the Tiger Global approach, which was also they’ve had some struggles and have been trying to liquidate large portions of their portfolio. So, we could argue that maybe that didn’t necessarily work. But I thought it was more interesting. It was also, I think, freaked the VCs out a little bit more, because their approach was a little bit more along the lines of like, “Let’s go buy the index.”
Yeah, there are these categories we care about. We don’t need to try to king make one company, because we don’t know if that’s exactly going to be the one. It might be the one, but maybe what if we have 3 bets or 4 bets or 10 bets or 20 bets. We’re not going to be board member, so we don’t have this board capacity constraint that the other VCs do. We also can be a little bit separated from arm’s length. And so, sure, we have information on the company, but we’re not going to be doing anything where even if we invest in competitors, that we’re not dictating that in any way. We’re just buying the index. We’re going to spray that money around.
If you believe that the venture ecosystem is the ultimate power law industry and that the winners will be so big that they overcome the losses, that will work out. If you do that across the big enough dollars, the dollar return on that could be massive. And so, it was almost like Y Combinator, but at scale. And so, that was interesting. It definitely made VCs really nervous in a way that the SoftBank approach didn’t exactly.
Tobias: Tiger Global made them more nervous than SoftBank. Why?
Mark: What’s that?
Tobias: Why was the Tiger approach more nerve wracking? Because I would have thought SoftBank comes in, kingmaker, here’s a whole lot of money. Now, everybody else is sort of trying to play catch up with that amount of money, and now you’ve got a big gun out there. Whereas Tiger Global is just saying, “We’re just going to size it according to how well it’s doing,” not knowing it doesn’t matter.
Mark: Because that had a better opportunity to squeeze out the existing VCs, because nobody, not nobody, but a lot of people were hesitant to take Masa’s money because of this, like, put a gun to your head like, “Are you going to take it? If not, I’m going to give it to the number two guy.” Tiger wasn’t playing that game. And so, let’s say you’re a high-flying series B company, and Tiger Global comes in and says, “Hey, we’ll give you $50 million. We’re not going to be on your board, we’re not going to be in your hair, you just keep doing your thing.” XYZ venture fund is like, “Well, maybe we’ll give you $50 million, but we’re going to be on your board, and we want to be involved, and engage, and here’s all the things.” It’s like, “Well, I’m just happy to take the $50 million. That doesn’t come with any strings here. I’m just going to keep going.” That was a much easier thing for entrepreneurs to accept.
Jake: Cov-lite money.
Mark: What’s that?
Jake: It’s covenant-lite.
Mark: Yeah, pretty much, right? Yeah. Obviously, they had, I think, pretty standard terms. But if you don’t have to take on a new board member, you don’t have to deal with all that rigmarole, and they would move super-fast, I mean, blazing fast. So, they’re coming in, open checkbook, “Hey, we’re happy to give you, I don’t want to say free money, but here’s easy money.”
Jake: Yeah.
Mark: Boom, you’re off to the races.
Tobias: Yeah, that was threatening to the VCs. Yeah.
Mark: For sure. Yeah. Now, to be clear, what caused Sequoia to go raise the large growth fund that they did was to counteract SoftBank, and to be able to have their own bazooka if needed. But it didn’t quite put the same fear of God into the VC ecosystem as Tiger did.
Tobias: We’re getting close to time. We got about three minutes or four minutes left. Let’s talk a little bit about Eads Bridge before we go. Your acquisition criteria is $1 million in EBITDA to $5 million in EBITDA. At that level, is that quite a competitive market? Because that seems to me like that size is what every search fund single-acquisition entrepreneur– That would be about exactly what they would target, wouldn’t it? So, do you find that to be a competitive space?
Mark: Yeah, it actually is pretty competitive. I would say, the growth of the search fund from the bottom up and how many search– Hundreds of searchers out there, lots more capital floating around. And then also from top down, where I think more middle market funds, private equity funds have started to dip down into lower middle market looking for anything that has a degree of fragmentation. Start to hoover up a bunch of companies package it up, and then go sell it off market, see some multiple expansions off market to the next guy, and move on. Yeah, it actually is a pretty competitive space.
Back to I think it was Jake’s point earlier of like, creating that Buffet dynamic, I think this applies to venture too. What makes Andreessen, and Sequoia, and Benchmark, these top firms so great is that the best entrepreneurs are knocking on their door. Now, it doesn’t mean you’re going to make perfect decisions, but you’re fishing out of a better pond. You flip them all.
Jake: Selection bias.
Mark: Yeah. And so, my thinking is, and I don’t know if this can be possible or not, but can we create a similar dynamic in the lower middle market? How do we create Eads Bridge holdings such that the best entrepreneurs want to come knocking on our door and saying, “Hey, look, we’ve got a great asset. We’d love to have your technology, playbook, and resources. Help take this business to the next level”? And so, we spend a lot of time around content and things like that to try to create the narrative and the brand around tech enablement for lower middle market businesses. Again, it takes long time and a lot of investment to get to that point, but that’s the ultimate goal.
Tobias: So, if there are people who are listening who may be interested in partnering with you, how do they go about getting in contact with you or what should they be prepared to show you to do that?
Mark: Yeah. And so, you can contact us through our website, eadsbridgeholdings.com. And then we have a Substack newsletter, subscriber list as well. We try to meet entrepreneurs where they’re at. We want to understand who they are as entrepreneurs, their entrepreneurial journey, some basic financial information, so we can get a feel for the business, and we go from there. There are a lot of intermediaries at this segment of the market too. There’s a lot of business brokers and investment banks. We don’t mind working with those folks. We think there is value that they provide to a business owner who’s never gone through an M&A transaction before. But for us, we really want to develop the relationship with the entrepreneur.
Jake: Especially if they’re not going anywhere. [laughs]
Mark: Exactly. That people mentality was something that was critically important as a venture capitalist, and it’s something that I still bring that bias today. I want to understand who these people are, what motivates them, what does success mean to them, what gets them excited. Are they ready to have a partner as part of the business as well? Some people are, and not everyone is. But maybe they’re not today, but maybe they will be in five years. Everything we do is really long-term oriented in that way. So, first and foremost, we want to develop that relationship.
Tobias: That was awesome. Thanks very much, Mark Valdez, Eads Bridge Holdings. Thanks, everybody. JT, you and I, same place next week.
Mark: [laughs]
Jake: Sounds good.
Mark: Thank–
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