Paul oversees the strategic direction and development of Arcadea across all areas of the firm alongside his partner, Daniel. Paul began his career as a member of the Citigroup Global Analyst program, where he gained exposure to a number of divisions before landing on the high yield and investment grade credit research desk. After Citi, Paul joined Arsenal Growth, a VC & Growth Equity firm in the US with offices in Palo Alto and Orlando. Starting as an Associate and leaving as a Principal, Paul focused on high-growth b2b enterprise software and eCommerce businesses.
Paul then joined Constellation Software (“CSI”), where he had a number of executive roles including leading the global investment team of one of CSI’s six operating groups, acting as CEO of a public sector business, and leading a group of businesses in various verticals.
On this episode, Chris and Paul discuss:
➡️ Lessons learned from working at Constellation Software
➡️ How they underwrite investment opportunities
➡️ Investing with permanent capital and a long-term horizon
➡️ How Arcadea creates value for their portfolio companies
(2:55) - Paul’s career and background
(6:28) - How was Constellation structured? Why was it 6 operating groups?
(8:14) - What’s the benefit of carrying a light corporate office?
(10:37) - Thinking in a high-clarity manner
(13:19) - Is there anything about your family’s history or your love of classical music that played into your ultimate career in acquiring SAAS companies?
(15:15) - How did you end up building Arcadea Group?
(17:58) - Does high growth always mean early stage?
(19:53) - Have most of these businesses you acquire taken on VC?
(24:15) - What is a Vertical SaaS?
(26:35) - What can you do differently operationally in VSaas versus other Software services?
(27:56) - What is Long-termism and why are you pursuing that route?
(32:55) - Do you only offer one injection of cash or do you inject as needed?
(36:38) - Who’s making the decision of whether the business needs more capital?
(40:16) - Do companies mature to a point where they no longer fit the Arcadea model?
(42:11) - What is a quick ‘no’ for you when looking at a company?
(44:54) - What happens in the first year of an acquisition?
(50:03) - What makes an exceptional operator?
(52:32) - How do you make your CEOs think like investors?
(54:51) - What are your investors expecting from you as permanent capital?
(56:27) - What does it do for your business to have such an accomplished advisor on your board?
(59:07) - What happens when a founder or CEO abruptly exits?
(1:01:30) - Are you successful because you’ve been in the seat of the CEO and operator?
(1:03:22) - What are Kanban and Scrum?
👉 Arcadea Group: https://www.arcadeagroup.com/
👉 Paul on LinkedIn: https://www.linkedin.com/in/pyancich/
➡️ Learn more about Xeal: https://xealenergy.com/
➡️ Fort Capital: www.FortCapitalLP.com
➡️ Follow Fort Capital on LinkedIn: www.linkedin.com/company/fort-capital/
➡️ Follow Chris on Twitter: www.twitter.com/FortWorthChris
➡️ Follow Chris on LinkedIn: www.linkedin.com/in/chrispowersjr/
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Chris Powers: Paul, welcome to the show. I'm excited to talk with you today.
Paul Yancich:Thank you very much. It's my pleasure.
Chris Powers: Okay, so you describe your business as we start where Constellation ends. So, I want to pick up there, but I kind of want to start with your career. I want to talk about Constellation a little bit and kind of the muscles and skills that you built there with your co-founder, Daniel, that eventually led to what you're doing now at Arcadia.
Yeah, sure thing. So briefly on my background leading up to Constellation, started at Citigroup and one of these rotational sales and marketing programs ended there on the credit research desk, from there I found my way to a growth equity firm called Arsenal Growth based in Florida and Palo Alto and we're focused on really high growth B2B enterprise software.
Also, some B2C e-commerce stuff that we did. That firm managed. Also, the Department of Defense's Venture fund. We did a lot of cyber, some vertical market stuff, you know, really just. Open Boar series A, series B, primary capital growth investing. And those are good guys. They're still active, still friends with them.
And around that time my brother-in-law, who's a portfolio manager at Fidelity on a value strategy, introduced me to this company, constellation Software. And he and I talked a lot then and we still do now about all things investing and otherwise. And he said, you should check out this guy Mark Leonard's letters because he used to be in VC and kind of went the other direction.
So, I became a shareholder, studied all of his letters, and I had started to think that it was time for me to look for another environment there from Arsenal just to learn from some other folks and get some different experiences. And I reached out to Mark and just asked him for some advice. He was kind enough to give me the time of day and one thing led to another and, and I was fortunate enough to be able to get a job working for Mark at head office.
And that was a very similar path that Daniel had had working in private equity. First in equity research. And he's like the Canadian side of this. It's equity research at one of the banks, then at a great private equity firm called Torque Quest. And then found his way after an operating stint within a portfolio company to Mark's analyst role that the co-carrying role head office.
A couple versions before me. So moved my family and then two-month-old son up to Toronto right when the winter started, which was a stupid decision I learned in retrospect to do that to my wife right when the son was going away. And just had a wonderful time there working for Mark. And then moving within into one of the six operating groups and what you learn at Constellation, particularly if you're lucky enough to get exposure to these brilliant investors and operators like Mark and my second boss, John Billow was how to think in a very high clarity manner. So, issuing this narrative approach to investing, which is really easy to get caught up in when you're talking with gregarious founders and instead looking at base rates and taking that tetlock approach to forecasting. You learn the science and art of vertical market software operating, at least I learned, that you can't be a great investor unless you have some operational scars.
And also, just the importance of keeping things simple. And you know, the best ideas are viciously simple. At the end of the day. They're not easy, but they're very simple. So, it was a wonderful few years there, Daniel had more, like six or seven, I had about three and a half or so, and can't say enough about that company and particularly the leaders that we are fortunate enough to work directly for.
Chris Powers: Okay. A few things you said there, I wanted to just dig in on for a second. You said six operating groups. What does that mean? How is the company structured?
Paul Yancich:Sure. So over time, as I learned from Mark, the company went from having, let's say, one acquisition to 30. And about that time, I think Mark and, and Bernie and the head office folks, of which there aren't many, and there weren't many ever realized that they couldn't keep up with this specific details of each company in each market.
And so, this idea around a portfolio manager or a group manager, which then became the operating group, GM or CEO of an operating. Formed and over time there went from, one to two to three over time, six operating groups when I left, the last of which being this company TSS. which was a big acquisition Mark led and, and Daniel helped a lot on.
And so those operating groups are formed loosely to start around specific acquisitions and verticals over time because of how much the constellation per view has flowered in terms of end markets. Those operating groups are now focused on a number of end markets. Each has maybe a core and a heart that they're most tied to in terms of legacy, but they're really going after a bunch of different groups themselves.
So, what you have now is a classic, very light head office approach. Like the best companies out there, the Berkshires, the Cap cities, all the books that Mr. Thorndyke wrote about in the Outsiders, the Danahers of the world, and the operating groups being much closer to their end markets and therefore more reactive to what was going on within those individual geographies or markets.
Chris Powers: Why do you think the best of these companies that you mentioned carry a light corporate office? I think I know the answer, but what is the benefit of that?
Paul Yancich:I think there are a few items. There's a culture of frugality at all these companies. That is really important, and you see it both within the corporate structure.
So having five to 10 people at a head office with tens of thousands of employees sets a signal to every other subsidiary entity within the business, if we the big public company, and now this isn't Constellation, this is, pick your great long-term compounder. If we can have six or eight or 10 people and we've got X billion or tens, billions of revenues, do you really need those five administrative assistants and 10 HR professionals?
And so, I think that's the first thing. It's a signal. Second, it speaks to the character and the values of the founders. And I think it's no coincidence that a lot of these super successful companies are founded by frugal cost-conscious individual. I don't think it works if you're a big spender and you're a flashy ostentatious person to pretend to be frugal, like this is the expression of the soul of these people in their businesses.
And I think one area where constellation's very different than some of the other high performing compounders, I'm thinking capital cities in particular right now for whatever reason is whereas Cap cities seem to keep the capital deployment, just like Berkshire, big capital deployment decisions within the select few at head office Constellation went the other route and tried to push that down as much as possible with the head office still of course, helping with the complex or large acquisitions. And I think not making any value judgment on that, it's just very different than most of the other high performing compounders out there. Daniel and I as we studied all of those high-performance conglomerates at head office and now have gotten to know another one very intimately in Danaher through our investor Mitch Rails, founder of Danaher.
We've made the conscious decision to try to keep as much of that capital deployment at head office and we can talk about the potential implications on organic growth of that later. But you know, that's my hopefully somewhat coherent explanation of this light head office and some of the implications for things like capital deployment and company culture.
Chris Powers: I love it. I've done 267 episodes today and I've never had anybody say something like what you said, and we'll move to Arcadia next, but you said they taught me how to think in a high clarity manner. And maybe just the question is that just a by-product of just being in the environment that you learned that, was there a process you went through to think like that, like.that was very specific, what you said. Clearly that had a huge impact. How did you learn to think that way?
Paul Yancich:A couple ways. So first is, this is a less scalable, repeatable way, but when you work for somebody like a Mark Leonard or Mitch Rails or a Dan Murphy, whoever pick your super successful workaholic, genius, capital allocator, you just end up seeing a different approach to thinking that is completely due to those individuals and how they develop themselves.
Now, unclear how all of them came to that outcome, but it's obvious to me that they all have high clarity of thoughts. So, when you're around that you start mimicking and picking up some of the approaches to thinking. That's the most generally scalable. The second is, we were very deliberate about how to forecast and my first year there we did an M&A conference and we talked all about this great book, super forecasting.
By Phillip Tetlock, where he laid out the academically and empirically proven best way to forecast, which is all about as many of your listeners, and you probably know, finding a relevant base rate and then adjusting based on the particulars of that insider’s story. So, getting your basian pryors corrected and then adjusting incrementally as opposed to starting with this unique situation, which many companies think they're unique and this is why it's different.
But there was a real framework for how to think about forecasting and investing in, at least in what we were doing there. And what we do at Arcadia is all about having some type of high-fidelity confidence interval around likely outcomes of businesses. And so, when you have a huge data set like Constellation did, luckily for the shareholders, employees, and everyone else, Mark saw the necessity of using that longitudinal data set that they had fought hard to create.
To help inform the future acquisitions. And so, I'd say those are the two ways. You know, and taking some philosophy and religion, glasses and thinking through hard stuff. And undergrad probably helped with my clarity of thought a little bit, but as it relates to investing, it was really those two experiences.
Chris Powers: Okay. I'm not going to throw you a total curve ball here, but I'm looking at my notes and I'm looking at what we just talked about. And given that it's just you and I today on the pod, your whole family was into classical music. You were into classical music and thought this might actually be my career.
And so, to kind of round that out, is there anything about your family's history or classical music that you can bring forward to what you actually ended up doing? Which is buying vertical SaaS, software businesses and investing?
Paul Yancich:People say that folks who are heavily involved in music have a quantitative ability and whether it's causation, correlation, I don't know if there's research on that and I was involved in much more than just classical and you know, everything from jazz to pop to everything.
I think that what I learned from seeing my family, I grew up in the house with my mom and dad is just like the necessary dedication. It takes over a lifetime to be an expert at something. So, I don't think it was necessarily just that it was classical music, but his is last year at the Cleveland Orchestra, he was one of these no different than a high performing athlete and a professional sports league or a high-end surgeon.
It's just, they're very few of those people. And for sure there's an element of inborn talent that's required. Beyond that, it's hard work and like extreme dedication to practicing throughout a lifetime and never slowing down and, you know, mailing it in at work. Because in an orchestra environment, if you have a bad concert, you'll get a warning.
If you have another one that year, they'll put you on probation. If you have one more mistake, they'll fire you. Like, if you miss a big note a couple times, you're gone. So, I think that's probably I hopefully what I soaked in and we're investing's a little more forgiving, I guess, unless you make a huge, huge error.
That's the only extrapolation I can think of at this time.
Chris Powers: That's awesome. All right, so back to where we started. So, you and Daniel came up with a plan and you started this wonderful company, Arcadia Group, that you guys kind of describe as we start where constellation ends. So now let's go from there. What does that actually mean?
Paul Yancich:We always want to be careful not to suggest that we're in some way better or anything like that compared to Constellation. And we'd also just to depersonalize it to Constellation, we also see ourselves in the spectrum of companies. So, what we mean by that as a quick heuristic is from an organic growth perspective, we're looking at stuff that's at least double digit percentage organic growth up to 150.
Most recent acquisition we made was close to 200% year over year organic growth for a couple years. And, you know, we happen to personally be more attracted to those types of businesses and the people they bring and the learnings that come with high growth than the low growth. But ultra high-quality businesses let's call them the aggregators of the world.
Constellation being the best, of course focus on. But again, it's not to say that we're doing the right thing and they're doing the wrong thing, but that's kind of where we sit. So, we don't see the constellations or their copycat firms. In competitive processes ever. And that certainly feels nice because it feels pretty bad if we were going head-to-head with a company that we have so much respect for.
But there's a different market need there for companies that are growing, let's say 30, 40, 50%, they're going to require a much higher price than, let's say the aggregators are typically comfortable paying. And that institutionally can pay, and we can pay those prices. And we're also, I think, a little bit different from folks on either side of us in that we're hyperflexible on ownership, so we're happy to buy a hundred percent, we're happy to buy 51, we're happy to buy a hundred and give options.
We can do structured, preferred if there's a big gap in valuation. And so, we hit this certain segment of the market that firms to the left and the right of us don't. On the left of us, let's say left equals slower organic growth and maybe a little bit more legacy companies. We're focused on the higher growth entities that don't associate with that segment of the market.
And on the other end of the spectrum, say to the higher growth acquirers and investors we're there to provide a long-term runway and path for our portfolio companies that the really high-quality private equity firms just can never do because of their capital base. So that's the Venn diagram of our ideal founder is they care about what happens to the business over a generation 10, 20, 30 years.
And on the other hand, they're growing, and they demand a realistic market price for the higher growth rates that they achieve.
Chris Powers: Is it fair to say that if it's high growth, that probably means it's earlier stage in the company? Or are you picking up some of these businesses that might have been around a long time and maybe and came up with a new product or something changed 10 years into the business that took them from flat to growing?
Paul Yancich:I think you're right in that there is for sure a positive correlation between. Absolute percentage growth and age of company. It's probably like a little bit of a J-curve of some sort and that when you first start out, obviously you're not growing at all. But yeah, I guess on average, relative to the slower growth aggregators and the PE firms that are trying to do the, also the roll up game of basically us efficiently liquidating annuity streams.
On the PE side, we are probably investing in and buying slightly younger companies. Yes, but some of them, including one we got last year in the FinTech space, that's about 9 million of ARR. It's been around 20 years, but the last five years have been the highest growth years ever in the company history, and are growing well above 20, 30% a year.
And so sometimes it has to do with a company's kind of early. And then the demand side of the market builds up around them over the course of 15 years, such that all of a sudden, it's an old company in the software world, old is 15 years, but they're finally hitting their stride with product market fit.
But, and on the other hand, we've got a couple companies that are founded within the past five years and just breaking out of the two, three, 4 million ARR range and for sure look more like what the typical venture capital firms would be investing in. But we have these founders who prioritize capital efficiency, like the idea of overtime having a dividend stream and don't want to play the perpetual rotating investor cap table game.
And they're like the idea of one partner. So, it's a mix of those company ages for us.
Chris Powers:And are most of those businesses started, the ones that you're buying? Have they already taken venture capital or most of these financed, maybe more like a traditional business would be and then you're buying them?
Paul Yancich:So, we've got about, if I think of the eight acquisitions or investments we did last year, it's about 50-50 completely bootstrapped versus some investment. And of the four, let's say that had investment, most of them were only maybe 500,000 million and half bucks of venture capital.
And in one case it was all a secondary transaction that a venture capital firm down in the Australia, New Zealand area came in to provide liquidity for the founders. So, they didn't even really take on primary capital per se. And the benefits of that relative to these companies having taken a lot of ECS is the founders owned way more of the business than they would've otherwise.
And we're of the belief that within tight vertical markets, if you give somebody 50 million or a million and a half and they're at a million of ARR, the outcome four years later will be the same. And in fact, if you give them 50 million bucks and are sitting on this mountain of capital and there's every quarter pressure from the VC guys saying, when is the next round, you can actually end up with a worse business.
Because if you have no constraints, we think creativity goes down and you end up doing all things mediocrely. Whereas the other end of the extreme with our completely bootstrapped companies, every decision had a huge fitness function attached to it. And so, the ones that survive are thinking about primarily what the customer needs.
And lo and behold, if you think about what the customer needs, you get this really high-quality business with low attritions. So, a little rambling of an answer, but there's a lot in there around taking capital on our part of the market.
Chris Powers: I think that's great. I think my only follow up to that would just be, traditionally if a VC has put money in, they want to see these huge multiples, then I would imagine if they've put money in and then they're selling kind of in the first couple of years, is that usually the owner of the business going, look, I really don't want this to be a venture scaled business. Things have changed a little bit. Let's make this more of a high growth business, but not these crazy outcomes that venture hopes for.
Like what's their discussion with the VC? Like when all of you come into play?
Paul Yancich:I think that illustrative conversation would sound more like, we won't ever be that snowflake or that Databricks or that Atlassian. It's because our market's just not that big. So, every company would love to become a billion of ARR in five years or however long some of these amazing companies take.
But I think founders, and if they're good, the investors also will realize, oops, this is a 400 million ARR market, so maybe we can get a third of the market. Right? So, 12 million, it's just like, you get to a hundred million of ARR, are you ever going to have a 10 million exit? No. And then you start working backwards into the time it takes to get there.
And I think that's an element more so than the founders say, ratcheting back their ambition. So that's an element. The other aspect of this is that founders will see what it's like to work for and work with the typical high-paced private equity or venture capital growth equity firm. And we're really looking at companies that have taken, let's call it growth equity as opposed to VC.
In my mind, VC is like, you got to be growing 300 to 500% something that a Red Point would invest in. But that's semantics. And I digress, and that can be a great place to be, but if you're growing 40% and you know, the VCs are supposed to be showing their LPs, companies are going 500% or 300%, even though you're having an amazing outcome, you're going to feel that pressure and that disappointment and the tension from the investors.
And so, I think there's some of that at play. And then lastly, some of these companies, they'll take some angel money and angel investors will get in at a low valuation and we'll buy it by a company at 10 million, 20 million, 30 million, whatever enterprise line. They make it a 20 x return on their money or seven x return.
And even though it's not a 200 million exit, it's still a really great MOIC for those early investors.
Chris Powers: Yep. Okay. Let's move into more of the nitty gritty of how you guys find deals and do deals and everything. But let's start real quick. You guys buy V-sass, which is vertical SaaS. What's the kindergarten explanation of what vertical SaaS means?
Paul Yancich:Software companies are focused on a specific end market of customers or a small collection of related end markets. So, you could think about the banking market is an end market and a software company that would sell into that we call the SaaS business, there's two elements of SaaS that are often conflated.
There's the technical delivery medium, which would be cloud provision, single tenant, single instance, or multi-tenant, single instance infrastructure. And then there's the economic model, which is annual subscription. And for some obvious reasons, people have smushed those together. But the SaaS that we care about has the more modern product architecture because we think there's some things that you can do from an operational perspective that are different than on-prem.
And so, most of our companies that are growing healthily at this day and age happened to be SaaS. And so, it's a good filter for us to just make sure we're getting more modern, high-quality companies. And that's it. And the reason behind the vertical, which is no secret to any software oriented or aware person now is with vertical markets, you have higher berries to entry.
You have defined markets that are more easily measurable and therefore hopefully more rational. Although that's not always the case with VC money coming in and, however many trillions of dollars of dry powders PEs have right now, they need to spend quickly. And we also think that these verticals are much more resilient to low code and no code, and the commoditization of development talent and you know, AI and things like that.
Because the real differentiator is knowing how a customer operates. So, most of our founders were former operators within the markets that they're now serving. And that understanding of how people work within a business, it's like totally unrelated to how easy it's to write to code. And you can snap your fingers and make code out of your imagination, but if you don't know how maintenance, repair, overhaul, shop deals with landing gear, refurb, then you're never going to create software that people want to buy.
You said in V-SaaS there's things that you can do differently operationally than maybe if you were in other types of software. Can you expand on that? What are a couple things you could do differently?
Paul Yancich:So, one is you have a faster feedback loop on what's working in the product vis-a-vis customer usage and customer friction points.
And you can do that because if you're relative to on-prem software, you don't see what people are really doing, you don't have a pipe into the usage data, you'd have to actually export or pipe into that customer instance, which is not something that typically folks want to. So, if you're cloud provision and the vendors actually managing that infrastructure for the customers, then you can see what everyone's doing, not in a big brothery way in this data obfuscation, obviously that's normal, but you can understand if people are getting stuck in certain areas or a few stitches dropping.
And then in terms of pushing fixes, it can be instantaneous. You don't have to send an update file that somebody on their end has to then push through to the customer to the instance. And so, you can have this continuous improvement of the code and be pushing releases every two weeks or four weeks, or six weeks as opposed to once a year.
And there are also some benefits around implementation and some support things. But the main story there is just the quicker feedback loop on the product.
Chris Powers: Okay, there are two core values that stick out the most. One of them called long-termism, and then we'll get into one size fits none, which I loved when I read on the website.
But let's talk about long-termism for a bit. That's something that's very important to you guys, I think. Differentiates. Why have you chosen long-termism?
Paul Yancich:So, there are three elements. There are many, but there are three that I'll talk about. So, the first is, I guess the softer of the three, and that's that we think back to this idea of like long term mastery in classical music or sports or surgical context.
We think that doing things over the long term is more satisfying to us and to the best operators out there. Feedback cycles in software businesses, any business really, I guess maybe it's consumer products or something, it could be faster. They're long, they're multiple years. And so, if a founder has a vision for starting from a rather narrow but high impact use case within their customer base to becoming a platform that's going to take 10, 15 years to do well.
And we want to be around for that whole journey. And we think also the best operators want to be around for that as well. And so, it's just a human enjoyment element and we think it has something to do with this hard to define word quality. And we can definitely make more money as an investor like us, and maybe as a founder, although I would argue against that.
If you're buying and flipping these businesses, particularly in the last 10 years, where every two months the multiples are higher. But you know, we're not optimizing for max money, and we don't think the best founders are optimizing for max economic outcome. Everyone wants to make money, obviously, but they're also maximizing for impact.
That impact is just a job well done over the long period of time, which is the only period of time that matters. If you do well over two years, that's nothing. It's meaningless. If you do well over 20, like let's say Danaher, then you're onto something pretty unique. And we also think they want impact long-term on their customers and employees.
And if your business is flipping every two or three years, you just can never have any kind of stability or trust built up in the employee base in our minds. So that's the first soft kind of like just for us, it feels right and it's less transactional and it's less exhausting to just be constantly selling all the businesses that you finally understand after three years just to make a little bit more money.
The second is the economic outcome can be better over the long term if you are patient, and I think it Bain did this, or one of the consulting firms put together a very simple study, some private equity transactions that they had seen in their advisory capacity over the course of, let's say 15 years. And those businesses were selling every three years and they compared that to what would've happened if the initial investor just held it.
It's several, several turns more of a multiple and invested capital because you don't have taxes. They're tax-free compounding. You don't have advisor fees and you don't have business disruption and distraction. And so put aside all the feel-good stuff, which is really the most to us, the biggest driver really.
But you can actually make more money over the long term. And you see that with, all the long-term compounders and I think about Danaher all the time, obviously just given how important Mitch is to our company as an investor and advisor. The third is least importantly, but more tactically, there is a market for people who care about the long term.
We happen to agree with that. It's not like we're just soullessly trying to find where we can hunt, but some founders, they like this and there's a demand for it out there, and we're there to fit.
Chris Powers: Yeah, I wish there was a way to really measure, as an entrepreneur, we think about our business a lot as things are either given your business energy or they're leaking and you're either gaining energy from certain tasks or you're burning energy.
And when you said you can take taxes and advisor fees, like we can quantify those, but if you could tangibly put a number on business disruption, distraction, I think it might be the most damning to a company of all of them. I think you're right, but how much so, you don't quite know.
But man, I think often if we had to come in and change our leadership team, or if half our leadership team left, or we had to invent a new product tomorrow to make some number work, we call it entropy. You're either gaining entropy or you're losing entropy, and every business is always doing one or the other. It's never stagnent.
Paul Yancich:I love that phrase, entropy. It's one of the things our family talks about is one of our values, just like low entropy. Our seven and four year old don't understand what that means yet, But to think about that in the business context I think is spot on.
Chris Powers: And then one other question. When you're buying for the long term, do you guys just buy the business and put capital in once and then that's it? Or is it kind of like, look, we'll continue to place capital into the business if it requires it? How do you think about that?
Paul Yancich:It's the latter. So, we could buy business and put no primary capital in.
Because at their current growth rates and what their situation is, we know that they should be making money. Conversely, with a business that we just invested in called Adsite, the one that's growing almost 200% a year, we put primary capital in day one. And there for sure will be some businesses that after four years we hit new growth banner opportunity and one, then we'll invest primary capital.
So, we're really flexible, and this gets to this idea of the one size fits none in that, you know, we have to be so rigid around business quality and what we're focused on. And so, we're so rigid around what we focus on in terms of quality and product, category, leadership, those sorts of things that have to be flexible, everything in every other manner.
And that's also somewhere that I think we differentiate from the other folks who outside observers may associate with us, i-e the constellation copycats, and then some of the aggregators, the PE backed aggregators that are, you know, is this proliferation now folks who say, oh, we're a holding company and, we're not going to sell your business, but if your backer is Aquiline or some other private, I don't want not to single M out or you are backed by a private equity firm and you say, we're forever hold, that's fine. Maybe you'll never sell the asset, but the whole company's going to sell one day because you have P money behind you.
But a big difference between us and that whole category is we are not rigid about how money is used. Money is just a tool. And sometimes the businesses don't need money and they never will. And sometimes they need some, and it's just like any other investing decision. So, we don't think it makes any sense to be religious around, oh, we don't do primary capital, or we have to get to 40% margins.
When you start hearing firms talk about that, and I hear about a lot of the constellation copycat aggregators out there is. It's because they're serving a greater master than just doing well over 20 years. It's they want an IPO or they've taken a bunch of debt and they need to pay it off. Or they've got a big growth investor who themselves need to flip it to show a return.
And so, it's like knowing is a message to the founders, knowing the capital and the real capital behind whoever your partner is will tell you a lot about them than what they say. Because everyone can say, oh, we're autonomous, or we're a big platform company, whatever end of the spectrum operationally.
And we think long term and we're hands off. But you know, if you got PE money behind it, you can be sure as hell. That's not going to happen. And again, it's not to say that PE model's bad, it's just different offering. And there are a couple of us out there, maybe not more than a couple handful who really have truly permanent capital and have investors investing their own money.
And who are thinking about a hundred year visions for their money. So, we're not the only firm out there like that, but there are way more kind of folks who push on that narrative, but who don't have the foundation to really adhere to that long term.
Chris Powers: You've said primary capital a couple times. I'll ask the dumbest question of the podcast. What does primary capital mean?
Paul Yancich:Primary capital being capital that goes into the bank account of the business that they spend versus secondary, just buying the shares basically. Growth capital versus not growth capital, you could say.
Chris Powers: Okay, fair enough. Is there ever a time where you could see that the business, who's making the decision of whether the business needs more money?
Would it be the CEO calling you saying, hey, we think we can put money to work and do this and achieve returns of this? Or is there ever a time where they're not really seeing it, but maybe you guys on your end are going. Hey, we think if we put a little money, more money in and do X, Y, and Z, you guys could do this.
Or is it usually coming from the founder to you or is sometimes it you to the founder?
Paul Yancich:Ideally over time it'll be the founders, the CEOs. Because the founders aren't always the CEOs, but the CEOs coming to us. And so, to get to that position, we'll get lucky with some who just understand this trade off between growth profitibality.
Spending capital versus getting there a couple years later, that's a difficult thing to ask of a CEO because they need to know software. They need to know their market, to expect that they also understand capital allocation. Just out of the blue is a tall drink of water for most even the smartest of operators.
So over time, our goal is to train closed loop capital allocators who are running these businesses, or at least overseeing some businesses very similar to the constellation model. So how do we get there? We think about just the trade off between a dollar today versus $3 tomorrow. Like any investor, it's simple.
And we were provided somewhat systematically a constellation. We're trying to be even more so deliberate about education is we're trying to provide a framework. That we've fought long and hard to develop for these CEOs to then adopt and fill-in in their own way, such that in some period of time they can make a data-driven, not story-driven decision with ample empirical evidence to support, let's say, taking margins down.
And it doesn't always have to be negative margins, right? Cause a lot of our businesses, even if they're growing 20, 30, 40%, they're making 30, 40% margins. So, it could just be taking margins down from 40 to 15, or for our businesses that are making 15% margins, we have some of those two that are growing fast.
It's taking it to zero. And then obviously it can go beneath zero in terms of EBITDA too. Whether we have to send you money or you're just using more of your own revenue, completely same decision process. One thing we are doing differently than, let's say at least Constellation, as I mentioned earlier, we want to keep the capital allocation at head office.
And the implication there around growth is if we allow a CEO, who's compensated on growth and margins to go buy business. And it doubles their revenue. That's a lot easier to double revenue by buying somebody and maybe paying a little bit stupid of a price. Or even if it's a good price, it's way easier than actually building those products and growing.
So, what's going to happen is people are economic creatures to some extent, and they're going to follow the path, at least resistance, go buy the company. And when you do that enough, you start developing your culture's devoid of organic growth instincts and bench and best practices. And that's something we're desperately trying to avoid at Arcadia, that I think is just a one of these other flywheel offshoots of buying organic growth.
You buy organic growth; you're going to get people who know how to grow. You're then going to have more growth opportunities for the team within there. You're going to have extra people who have already learned how to do growth and who are going to be able to spin into another business. Now the base rates, instead of being a 2% organic or 3% organic entity, now maybe your average organic rate is 20%.
Well, you start having a different level of expectation and to put in capital deployment anywhere around there is just going to muck that all up in our mind.
Chris Powers: Yeah. And to be clear, the longer you own a business, like if you were to own something in year 15, you're not expecting it to be continuing me growing at 20, 30% a year, 15 years later.
Or is there a point at which it's growing? So, it's like matured that you guys are thinking, well maybe this doesn't fit our model anymore. It fits more of maybe the constellation model or somebody else that was okay with maybe a more mature, slower growth business.
Paul Yancich:Yeah, nothing can grow forever at even 20%. We think about growth being limited by the size of the market and the amount of opportunities there are in any given year to win new customers. So, if you have a hundred decisions a year and you have a 50% win rate and each of those is $1 of ARR, then you can only grow $50 of ARR per year, put aside pricing and back to base expansion.
So inevitably your percentage growth is going to decline. So, what we're trying to do here is extend growth curves as long as we can. We'd rather have a long healthy growth curve than a high ARR, low duration growth curve, which typically means you're stuffing crap into companies that they don't really need.
So, like a little bit more of the slow growth trees are typically a little bit more durable and strong over long periods of time, but it's just that we want our, all of our companies to forever be doing double digit. It's impossible. At some point, some of our companies are just going to run out of market.
But we've seen other companies do it for a long time, and the key is we'd rather decay from a point of 25% average organic growth and over 30 years end up at 12 than start at six and end up at below inflation. And that's just where we are in. But there are some exceptional companies that have shown the ability to grow over 20 years, and luckily that'll be some other guy on our team's problem in 20 years.
Chris Powers: All right. I was going to ask how you guys source, but maybe a better question to start would just be, assuming it's a vertical SaaS business that's growing, what is a quick no for you guys?
Paul Yancich:A quick no would be the solution being a nice to have, a nice to have something that you can turn off pretty easily in a downturn or if there's another flavor of management within your customer. These often but not always look like point solutions and you know, it's how do you teach young people what that is? I think it's one of these things that just takes a lot of experience and you need to let your brain run its inference engine and start to realize like by actually working in a real business what matters and what doesn't.
Another way to think about this in our mind is, you know, who creates stores and moves data across the ecosystem, across the customer base. So those are some kind of rules of thumb we think about. And if somebody's just using data to do something that's marginal and you know, it's not for us. So that's one.
High attrition is another. So, do you lose 10%, 8%, 12% of your customer's year? It's not for us. Also, we're careful about jurisdictions, we only invest in places we'd be willing to send our families without us for two weeks. It's kind of a rule of thumb. So that's a personal thing.
Some people would say, I'm happy to send my family to here and others wouldn't. But we try not to let the fact that we're from Ohio and Ontario influence us too much in a way that would be unduly biased.
Chris Powers: Does Texas pass?
Paul Yancich:It does, yeah. Texas, Australia of the United States, and vice versa.
We love Texas and Australia, I love it. So, those are quick passes and then like, you know, an unrealistic, just completely out to lunch CEO with founder CEOs, if they're too rational, they're never going to start a business because the fail rate is so bloody high, you got to be a little bit irrational and overconfident.
But also, it's at the very low end of our growth curve, it's 10% growth, 11% growth, which is already, we're kind of like, should we even bother? It's got to be such a good business in other areas. And they say, yeah, I just need $2 million, and I'll start tripling every year.
And you know, there's nothing behind it. Even if we can convince them somehow to sell at a fair price, we know that it's going to be a headache with that CEO and it's just not worth it for us because we're not trying to just buy as many as we can. We're trying to buy the right ones. Some easy, fast passes.
Chris Powers: Okay, you closed on a business, we found a great one B-SaaS. What's happening in that first year? And I know it's not one size fits all or one size fits none, but traditionally, are there some core tenants to what you guys are trying to accomplish in that first year? Is it truly every business is different.
Paul Yancich:Every business is different. But there's some core things that we try to put through. So, our process is hat tip to our managing director, Ryan Beaver came in and supercharged our process. He's an engineer by background, has done everything from developer to architect, CTO, VP engineer, COO. He was my CEO when I was operating.
So, he did everything pretty much and CEO himself. Just amazing extreme outlier operator, like top 0.1 percentile. We're super lucky to have him. So, he's come in and put a developer's mindset around this concept of value creation. So, we run a scrum style approach using Microsoft DevOps. Every single item that we've discovered in diligence and that is our typical best practice for us. Because there's some tried and true best practices and then there's this huge massive library that just depends on the company we assign a card to, it has acceptance criteria. We run scrum standups, you know, we pull stuff into working. It's just like a development team. And that allows us to do something which we don't think really any other firms can do.
Because you know, you're talking with software developers typically, and they don't want to see Excel, they want to see Trello or DevOps. So that's our process. Obviously, I'm not doing it justice, but very detail-oriented with every company there. And that saves so much time. And then the things that we always want, and we need the certain measurements that we rely on and that we want our CEOs to rely on in the business.
So that's some basic things in sales and marketing. Nothing new, you know, what's your, what's your funnel? We often have to help rebuild funnels so that they're. Weighted and sized based on data as opposed to finger in the air. So we'll get those funnels oftentimes tuned up. And then we want measurements around that.
So, you know, days in stage and customer acquisition costs, gross margin, months, payback, all this stuff that, you know, Tom Togas, formerly Red Point could talk about much more eloquently than me. And then it's the same one to two or three metrics in each of the five functions of software business. So, there's sales and marketing, professional services or implementation support, whether you call it, R&D which is everything from product management to development, to architecture to engineering in our mind. And then, general administrative.
And so, each of those has a couple key metrics that we've learned from our days in growth equity, private equity constellation, and that we've developed ourselves through some value additive synthesis and we got to get those in because you can't measure the business. You're running blind and you're running off gut.
And our whole thing is there's no more gut. It doesn't mean you take the spirit out of what people are doing. Product ideas especially are often like inspired ideas, but they have to also be connected to data.
And that's what we're so focused on in that first two, three months. And then our goal is to help train and teach those CEOs and their functional leads how to think like an investor about their business. And really, like I said earlier, very few have that capability. And it's not a critique, it's just like, hey, they've been operating.
If you have a data set event equals one or two software companies your whole life. And we have over our combined experience has seen 500, 600 across all the firms we've worked at. We're obviously going to have a better understanding of what works and what doesn't. And that's our relationship with them. And that's what we try to get done the first few months.
Everything else is depending on the company.
Chris Powers: How do you get the data and the metrics? How do you actually get those down into the company? Do you have them download a software that tracks all this stuff? Like how does it make its way into the company?
Paul Yancich:Every company's a little different. So, Ryan has a team and all of us, so it could be Ryan, Andrew, who's on his team, and maybe one of our associates, Luke, Tanisha, Thomas, whoever worked on the investment.
They will be whatever the company needs them to be. They could be hands off coach, could be an analyst, or they could be the person going into, let's say, Salesforce and building the new dashboard. So, we meet each company where it is, but we don't have like one master BI package that we stuff in.
It's oftentimes just using whatever systems they have and then ensuring that they're pulling the right data out. Because this data exists, it's just about corralling it and capturing it. So, we try to make that as light a touch as possible for the companies. The trade off is if you do everything for somebody, then they don't learn it and they don't own it.
So, a balance is there that we have to walk.
Chris Powers: All right, we're going to give a shout out to Ryan who you said is the top percentile operator that you've ever met, and he is kind of a unicorn. If you just had to say, what does he do in a simple way, what does he do better than everybody that makes him such a great operator? Or what are a couple things he can do that most people just can't?
Paul Yancich:So, the first is he understands, he speaks the language of. Engineer and capital allocator and business person, like very few people do. You know, I understand technology to heuristic layer maybe a little bit better than that in some instances, but I can't code, I don't know, is Excel code?
I can do Excel code, but I can't do real code. Ryan can, and he understands all of these technologies in a layer that is extreme expert. And at the same time, because he's been a CEO himself, he understands the pitfalls that come with being only an operator.
Because if you let a stereotypical high-end engineer run things and they're just brilliant and that, products will never be done, they'll never be good enough. So, he's just got that unique mix of being commercial. Also being extremely effective with people, being a compassionate guy and knowing technical elements.
He's also a monster. So you know, in person, you're a little afraid of him, which Mark also had as a superpower. So that's the first thing. He's just like a polymath in everything software. And I think the second is he's extremely process oriented. So, he's got everyone on Eisenhower boards and running our internal teams on a scrum basis as well, two week sprints.
Monitoring throughput, planning poker for what we have to get done. And very few people know and have the interest to apply that developer skillset within a more general business context. And then lastly, he's just seen it all, right? He started constellation when I think he was 22, back in 2000 or 2001 with within one of the first acquisitions that was ever made.
And you know, he's only 43 or 44, something like that. His whole time was built up within probably the best, most disciplined operating context in the world, and yet he has the heart for growth and building something that matters.
Chris Powers:I can hear it, I can just feel it on this end of the mic.
That's super cool. If I was talking to one of your CEOs a year after you bought him and said, what are the few things that they did to make you think like an investor, you were an operator when they bought you, and now maybe it takes a few more years, but let's just say at the end of some point in time you guys had said they're finally getting it.
What would they tell me that you guys had done for them to make them, help them think that way?
Paul Yancich:Well, I wouldn't take too much credit for the CEO that gets there. So, they would've done for themselves, what they would've done is embraced the very simple basic frameworks of reporting, measurement, and decision hygiene.
And they would've implemented that in their business. it's kind of nebulous. So, a concrete example would be like, Gosh, if a CEO came to us and said, you know, hey, I know we have this plan for the year that's this team, these rough margins and growth is what we expect.
But I want to go outside of that, and I want to hire two or seven more people, and here's why. Number one, we've opened a new growth avenue in the market and here's the data that we see in the top of our funnel showing that it's already converting at a higher rate to the mid stage. And therefore, we have high confidence that our revenue is going to beat by a massive amount even though we haven't signed contracts.
Number two, we are seeing an opportunity relative to our competitor who is slimming down in pro serve. And if we can spend a little bit of capital now to over-deliver on implementations, it's going to lead to a very compelling market story for us. And number three, we have a couple people who we think may not make it to the next level, maybe one or two.
And I don't want to wait given where we are with growth. To get those people replaced. If a CEO came with that type of data and also had the implications of the budget, you know, we don't have a budget per se, we have forecasting but implication on the forecast, then it's like, okay, well our job is done here, then all we're there for is to be a thought partner and a sounding board that has some critical distance from the heat and emotion of the day-to-day of a business.
So that's what it would look like. And again, how they get there, it's just kind of leaning into our process, which is we think very similar are probably what Berkshire Hathaway does with its companies. And you know, the Danaher Business System touts with its operators.
Chris Powers: You've talked about Danaher quite a bit, and Mitch, and he is also one of your investors.
So maybe we can get two questions out of this. The first is, what are your investors expecting from you guys as permanent capital with a hundred year visions, again, when you're measuring in three to five year increments, it's easy to go 20 IRR over five years is what you should expect. What is somebody that thanks on a hundred year vision expecting from you guys, and how do you know if you're doing a good job or not?
Paul Yancich:In 20 years they want to make it somewhat human scale, a huge multiple of invested capital as measured by the then present equity value of the business. So, you know, 30, 40 x MOIC on this initial capital, something like that. They want to see an elimination of reinvestment risk. I don't want cash that.
Because then you got to do something with it. So, they want that cash to be perpetually at work with us. Obviously that's where a lot of that MOIC comes from is redeploying the initial capital at productive rates of return. And I think that's the simplest way to say what they want from an economic perspective.
And you know, each of them has their own personal ambition for their money. But for sure what binds them is nobody wants it back in five years because none of these people are trying to buy the next boat. You know? Or if they are, they got plenty to do that without their capital in Arcadia, whatever the case may be.
So that's most simply what they want and that's their biggest challenge is finding places to put capital at productive rates in return without having to recycle it all the time.
Chris Powers: Okay. And then maybe we can just go a little deeper. What is having somebody like Mitch, I don't know if he's on your board, is he on your board, but he seems to be someone that picks up the phone when you guys call.
Maybe it's like a broader discussion because anybody could relate to this in their industry. But if someone was able to have someone as accomplished as Mitch close to them, what would that do for their business? What does it do for youR guys business?
Paul Yancich:So the first is, the lowest effort for a guy like a Mitch or Brad Bloom, Ross Jones from Berkshire Partners, or Caleb Andros or any of these great folks we have is, it's a great example and something to aspire to.
So, you know, whenever you talk with somebody who's done something the right way over long periods of time, it's just great motivation and we're pretty intrinsically motivated guys, but doesn't hurt to have that example floating around in your consciousness all the time. And that's the simplest, but they don't even need to pick up the phone to do that.
The second is really helping keep things simple. And that's where I think Mitch is, you know, has a superpower. He's obviously extremely genius level intelligent, but like we discussed earlier on in the show, the things that move the needle the most are simple. And if you're in the heat of decision about, should we make this really big acquisition that could use a third or 50 or 60% of our hundred percent of our remaining or anything like that.
And we're obviously going to talk to some of our large investors that get their insight because why wouldn't you, you know, to hear this, the Kai clarity of thought and the simplicity, the focus on quality is extremely helpful. And the least helpful would be the investors and we don't have any of these, but an investor who tries to get really technical and well, how did the last quarter work?
And have you thought about how could you move attrition by 50 basis points? And what's the tech, it's like, is it a quality business? Do they have market leadership? And in those discussions you realize and you're reminded of what really matters. And so that is extremely helpful since clarity of thought, low emotion decisions is everything.
And then there's a lot more tactical stuff. So, learning about the Danaher business system, how they've done acquisitions, how they deal with the people side of businesses, the pace at which they can make change, mistakes they've made, all that sort of stuff is, you know, invaluable. And we're really grateful for that.
Chris Powers: Okay. I have two questions left and I know it's early. You guys are relatively young in your company life, but you probably come across this before, but you buy a business founder is all in on wanting to move forward and then they've been operating for a couple years, and then one day they call you guys and they're just say, I'm done.
What happens then? Because you're holding this thing forever. Do you actually think about a sale at that point? Or I'm assuming a passionate founder's not just lock, giving you your two weeks notice and they're gone. But how do you think about that if somebody has, I'm sure this has come across your desk at some point where the founder just says, I don't have it anymore.
Paul Yancich:Yes, absolutely. It's going to happen. It's happened so far with us, but not in an unexpected manner. So, we had a founder, CEO who said, I've got between six months and 18 months and after about a year said, okay, it's time. The good thing about these businesses that we focus on, especially once we get our hands on them and can further increase the quality, although they require high quality people to grow, these low growth businesses, you could have anybody go in there and for a few years is going to be able to get margins and extract from the customers.
But that's our model. So, we need good people. But there's incredible inertia with high quality businesses such that even if the CEO were to disappear off the face of the earth. You have six months before anything disastrous happens. You might even have a year. We try to keep some zen around that and realize that even if you lost the top three people within a company, it's not going to unfold on you the next day.
But we have a culture of extreme honesty and directness. Even if that means sometimes that the friendship element of work is a little bit less at periods, it doesn't matter. Honesty is over everything for us, as long as it's humanely delivered. And that allows you to really have a good understanding of where those CEOs and operators are.
And they also have a good understanding of where they sit within us, the owner ultimately where the owners are approval of them. So, you shouldn't have too many surprises. And then lastly, if you do, hopefully you have some people in the business that are constantly being trained up so that they could step in and fill that spot.
The last resort is of course, Daniel Ryan, myself. We could all step in and be the CEO of a business for some period since we've all done it. But as you know. That's not what we're designed to do. And talent’s everything, but there's some real momentum, I should say, with these businesses that gives you some forgiveness.
Chris Powers: Do you think the reason why you guys are special and why you guys can do what you do is because you guys have been CEOs and operators before?
Paul Yancich:If we are special, I should say then I think somebody else would say it's a mix of a few attributes. First is we've been very lucky to have a wide variety of high quality investing exposures, which is in the early part of our career, it's just dumb luck and good fortune. And then as we progress more to do with our own hard work and success. So that's the first. We've been trained exceptionally well, I think, and we've been trained by exceptional people. Number two, we listened to Mark, and in my case, John Billow and Daniel's case, Dexter Selma, and listened to them loud and clear and said, if you don't operate ever, you just always going to be a bean counter and you'll never really understand what to do and how to do it.
And so, we don't think we're the best operators in the world, but we've had enough of the shrink wrapper removed and enough scar tissue built up to at least have empathy if nothing else. So that's unique. And then I'm sure there's some personal attributes, you know, and we have a good partnership between me and Daniel, and I think we're also extremely like pretty self-flagellating guys.
And that's super required to do well over the long term. As soon as you think you smell good, it's over, maybe it's deep personality flaws. We're our worst critics and that's going to stay forever. So that can be painful at times, but it's, really helpful, I think
Chris Powers: Your level of humility, I can just oozes through the episode.
That's how I would characterize you in the most positive way possible. This last question's for me, and I'm meant to actually ask it at the beginning, because when I was doing research I was like, I've never seen this before, but you've actually said the word a couple times, but somewhere I came across religious about using CanBon and Scrum to manage Arcadia in our lives.
Paul Yancich:KabBan and Scrum are two types of work process methodologies. So KabBan is like the easiest way thing we got KabBan is it's, it's what Trello is. You have cards, you move it from the due to doing to done, and there's a whole system around what that looks like. In other words, it's just like, whatever cards are up there, you just take them.
Some have more points, some don't. But all your goal is to just get stuff from in-process to done. You don't want to get a lot of stuff stuck in process. You get more points for completing something. Scrum is an approach, it's a type of agile methodology that's about more sprint oriented. So, you have these narratives and it could be a two week sprint, four week sprint where you're going to get certain things done.
It's probably way overboard, not what I'm saying, but the religion of Scrum has gotten like way out of hand. It's like all these rituals and it's like religious terms, rituals and the scrum master and all this stuff. But basically, it's about being agile and having short iterative feedback loops.
Then there's confusing, there's scrum ban, which combines scrums, it's just somebody's making it up. But we're religious about that because we expect our companies to operate that way in the development, which is the heart of the software businesses, the development function, and it works really well.
And there's a lot of smart people inside development divisions within companies. So, it would be foolish not to leverage it. It also helps just keep us super organized. We never wake up and think, what am I going to do today? Or what's the most important task? We know exactly what we have to do, what's urgent, what's important, what's the stuff you just throw away?
So, it's just a way to live life. And that's it.
Chris Powers: Paul, this has been awesome. I really appreciate your time today. I know you are in Park City getting ready to go ski, which is a great second half of the day.
Paul Yancich:You got to tell your listeners, I didn't realize I'd be on camera. So, you can see my bed in the background of one of my college roommates is over in the corner doing work for a guy, so I have to buy him luncheon beers all day.
But hopefully it's not too offensive and thank you so much. Really appreciate it, Chris. It's been been amazing.
Chris Powers: No, it was a pleasure. Thank you very much.