Join us for an in-depth session on thematic investing, a powerful strategy embraced by private equity (PE) firms to capture emerging trends and drive superior returns. Mark Gartner, Managing Director at RLH Equity will help you understand what thematic investing is, why it is gaining traction among PE firms, why you should care and what it could mean for your firm.
TRANSCRIPT
Greg Alexander:
Hey, everybody. This is Greg Alexander. You’re listening to the Pro Serve Podcast brought to you by Collective 54. If you’re not familiar with us, Collective 54 is a community for founders of boutique professional services firms. We want to make more money, make scaling easier, and make an exit achievable. On today’s topic, we’re going to talk about thematic investing. We will discuss what it is, why you should care about it, how it impacts you as a founder of a boutique pro serve firm, who eventually, someday, may want to sell your firm to create a liquidity event, a wealth-creating event. Joining me on today’s call, we have a long-time member of Collective 54. His name is Mark Gartner. He’s with a private equity firm called RLH Equity, which embraces, as an investment philosophy or strategy, the concept of thematic investing. He’s going to give us a brief tutorial about it. So, Mark, why don’t you introduce yourself and your firm briefly to those who may not know you just yet?
Mark Gartner:
Yeah, great. Thanks, Greg. I’m very happy to be here. As a private equity firm, as you said, that’s been around for now 42 years. For decades, we’ve been exclusively investing in professional services companies. This is a strategy where we were effectively swimming upstream. A lot of investors were leery of the professional services category because the traditional private equity playbook didn’t apply. The things we care about are leadership, continuity, culture preservation, and organic growth. In most cases, we do not rely on debt and we do not attempt to engineer our way into good returns. We do it the good old-fashioned way, nurturing revenue and growth, and positioning a company to be attractive to the next buyer. So when we found Collective 54, I like to say we became fast friends. So, very happy to be able to talk about thematic investing.
Greg Alexander:
Yeah. Awesome. So let’s start with the basics. Why don’t you give us a definition of what thematic investing is?
Mark Gartner:
Yeah. So thematic investing is a strategy where you invest in companies that are poised to benefit from a long-term trend, nothing more or less than that. Generally speaking, it’s a trend that will continue for 10 or more years such that both you and a future investor will benefit from it. That’s very important because, yes, you would enjoy the benefits of the tailwinds behind you and the benefits of that trend. But a new investor and buyer has to see similar promise in the industry in order for you to get the best valuation. The other thing I would say is that it’s also a trend that you can very easily explain to somebody, and do so without relying on jargon specific to your industry.
Greg Alexander:
All right. Well, let’s test that theory. Give me an example of a theme that RLH is investing in now. We’re looking for investment opportunities and explain it in simple terms.
Mark Gartner:
Yeah. Okay. So the trend from which our strategy has benefited the most historically has been digital transformation. Now, that may sound like a jargon-style term, but I’ll get into it. This is simply the notion of using technology to improve how a business operates. That’s it. So we decided to pursue investments in companies that are involved in technology strategy and technology implementation-related work. A good example of that would be a business we invested in many years ago called Blue Wolf. That company has a lot of name recognition in the community, which is a prominent Salesforce.com consultancy. We invested in Blue Wolf through a period of rapid adoption of Salesforce, and the services opportunities surrounding Salesforce grew commensurately, and companies like Blue Wolf benefited. So you can see how you start with the trend, the adoption of Salesforce.com, and figure out what is the derivative around that creates opportunity for investors.
Greg Alexander:
That is a great example. I remember Blue Wolf, and they rode that Salesforce wave better than anybody that I know of. You did very well riding that theme, if you will. So that’s a great one. Follow-up question to that is how do you determine what’s a real theme with legs versus a fad that might be gone in six months?
Mark Gartner:
Yeah. I think that comes down to investment judgment. The best recent example would probably be cryptocurrency. There was a wild bonanza in that arena, and everybody was buying NFTs and the next coin that was coming out. It’s hard not to get caught up in that. So you have to be really careful, and that’s where it comes back to being able to explain something very simply. Most people couldn’t explain what cryptocurrency was or why it had value. It was just pure speculation. So it’s got to be something rooted in good old-fashioned truth and understanding about why that’s going to continue and why people should care about it.
Greg Alexander:
Yeah. Another question regarding this is that having gotten to know you and your firm, there’s a certain size of firm you want to invest in, a certain EBITDA threshold or revenue threshold, certain organic top-line revenue growth you’re looking for, and it can be in the world of professional services. I wouldn’t say these are big firms, but they’re certainly not startups. So, by not investing early, waiting for a period of time to where the firm has reached some level of scale, aren’t you missing the wave?
Mark Gartner:
You can. It depends on the growth trend of the theme that we’re talking about. Let’s take the trend of AI, for instance. If you wait until a professional services company has $25 or $30 million of revenue, you may miss others who would come along and seize the growth opportunity and they would have moved more quickly. For themes like that, which show meteoric growth potential, we are having the strategic conversations about why not start sooner. In those situations, we might start a little bit smaller. Generally speaking, though, for a pro serve company to qualify for our strategy, we really look for at least $25 million of revenue. That is a threshold that a lot of pro serve companies don’t get to. If you can, then that demonstrates a level of sophistication and leadership and the wherewithal to scale to $50 million and above.
Greg Alexander:
Yeah. Okay. Very good. If I’m a member of Collective 54 and I’m listening to this and I want to embrace the principles of thematic investing for two reasons. Number one, I want to ride the wave as well. If I can learn how a professional investor like you evaluates themes, because the possibilities here are almost endless, how do I pick the right theme to go for? You guys picked digital transformation. That makes a lot of sense. So I’m listening to this, I want to ride that wave. But also, I eventually want to sell my firm someday. If I can embrace this concept, I make myself more attractive to a potential acquirer like you. What advice would you give a member of Collective 54 who wants to embrace thematic investing for those two reasons?
Mark Gartner:
Say that in identifying themes that you should architect your business around, they’re gonna be fairly intuitive. In many cases, it’s gonna be the things you’re reading about. There’s gonna be so much repetition, you know, in the world and the data that’s you know, assaulting your consciousness that you’re gonna know what some of these themes are, and it comes down to figuring out which ones are the enduring and most powerful themes. And the best litmus test is, are you architecting your business such that you would want to invest in it today? That’s how an investor is going to look at it. If I were to rattle off some of the themes in which we’re interested, you’re gonna be like, yeah, that makes sense. That makes sense. So here’s a few AI related services, data, science, engineering and analytics, you look at basically unrest in the globalization, the world. So we might say things like policy and regulatory strategy might be interesting supply chain optimization. You know, we saw it happened during COVID where supply chains effectively broke and eliminated all the vulnerabilities that exist in the global supply chains, precision medicine, data center services, you know, the explosion, of AI on the data that’s being created. That data has to be housed somewhere. It’s probably gonna be in data centers. And so what is the derivative opportunity around that? So I think it’d be hard for people to argue with these things. And so it’s up to you to figure out which one is most relevant to you and your business.
Greg Alexander:
Yeah, great advice. And, I might add to that, you know, if you are a firm that has scale and you eventually want to sell, the other thing I’d mention is, you know, be able to position yourself correctly, like category selection is really important. And if you put yourself in the category of digital transformation, that’s probably a little too high level. But if you put yourself in the category of digital transformation by implementing large language models and life sciences, right? So now somebody like Mark and his partners at our equity can understand who you are real quickly and understand if you’re in alignment with a theme that they’re embracing or not. Let me ask you this question. Within the investing world. There’s kind of two schools of thought. One is bet on the entrepreneur and the other is bet on the idea. So thematic investing is clearly betting on the idea, not betting on the entrepreneur, but is that true or we need both?
Mark Gartner:
You definitely need both. And this is an old adage investing which is if you get the industry right? And you get the CEO or the entrepreneur, right? It’s probably gonna work out pretty well. Now again ideas and trends are helpful, but execution also matters. What I will say. And, I don’t want to diminish the importance of either of those things because I’ve seen situations where favorable industry growth can sort of mask suboptimal managerial decisions. And at the same time, I’ve seen moderate industry growth be superseded by entrepreneurial prowess and people can grow beyond the industry. So both of those are extremely important, but you have to have those two things as a starting point.
Greg Alexander:
Yeah. You know, if we look back to your success with blue wolf… how long in your opinion, when you guys were thinking about making that investment, I know it was a while ago. So this might be an unfair question. But how much runway did you think the, you know, that the Salesforce, dot com growth ecosystem was had in front of it?
Mark Gartner:
Based on the diligence we did during the process, we didn’t see a practical end insight in the near to mediate term. So we felt like it was gonna be measured in decades. We felt like the CRM was gonna be basically an unstoppable force. And indeed, you know, Salesforce Dominic continues even to this day. So I don’t know that’s what involved in our confidence. And in the case of blue wolf, they had a wonderful name in the industry. We have tremendous confidence in the management team. And ultimately, you know, the buyer of that business was ibm and they felt like that was a must have asset. And so the overlapping of all of those forces resulted in a tremendous outcome.
Greg Alexander:
You know, another old axiom of private equity investing is think about exit upon entry, right? So have an idea because I mean, your business says eventually you have to sell these firms that’s the nature of private equity and you sell them to the next owner and they take it on the next ride. I mean, in the case of blue wolf, they sold to ibm, obviously a legendary company, you can see why that made logical sense. And I’m sure blue roof has reached its potential and then some by being part of ibm. But so when you’re thinking about thematic investing and you’re thinking about making an investment in a possible portfolio company, how do you evaluate who you might sell it to? You know, five to seven years later?
Mark Gartner:
Well, buyer interests of over time. So you can never perfectly predict it. But actually you can assess they’re called buyers sentiment surveys and actually a lot of investment banks do a pretty good job of this of canvassing the strategic M and a priorities of the strategic buyers. And so you can get access that information today. It doesn’t mean that’s gonna be the same in five years, but you’re absolutely right? You start with the end in mind, you work backwards, what do you want the press release to say? And the good news is because we’ve invested in professional services companies for so long what good looks like. And some of these truths are timeless, you know, what margin profile you’re looking for, you know, what the service offering needs to look like. You know, what the vertical focus should be. You know, you know, what a management team looks like, they can scale a business to be larger. And so some of these things are true, your respective, the situation and not every company needs every element of the playbook. Some companies, are further or less far along on their journey. But you just have to know what the company needs to get to that great instant. Yeah.
Greg Alexander:
Yeah. You know, I would point members to a couple of collective 54 tools that might be helpful here. One is the firm estimator, it’s a quick tool that allows you to figure out what your firm might be worth, the reason why it’s relevant to today’s. Conversation. You know, Mark just rattled off a few things a margin profile et cetera. This tool allows you to go through and it has benchmarks embedded in the tool to enter your data and, the value of your firm goes up or down based on, you know, are you at below or above benchmark in that area? That’s an example of thinking about exit before the exit. Because now you’re going to run your firm differently. Even if you don’t plan on selling for many, you want to increase the worth of your firm. And if you think about what an investor might be looking for it today, you can make better decisions. The other one is the exit readiness checklist. This is a rather long form. I think it’s got like 140 questions. It’s basically mock due diligence. It allows you as the founder to put yourself through due diligence to see if you can even get through due diligence. And again, that’s embracing this concept of thematic investing or acting like a professional investor, thinking about exit upon entry and actually, one other point I would make on that Greg, is we have our own version of that. We would call this the RH scorecard. We probably need a better name for it, but it’s every strategic and tactical KPI, you know, that we have extracted over time that a professional services firm should pay attention to with, the book ends of viability, you know, low to high, where do you want to be on that range? And so if anybody ever wants to talk about what’s on that scorecard, where they might sit between those book ends, we’re getting to do it in.
Greg Alexander:
It’s reasonably long as well as comprehensive. And I would think very helpful.
Mark Gartner:
Yeah. Is that something that a listener to this podcast could just download off your website or is that proprietary?
Greg Alexander:
We would definitely share that in one-off conversations. I don’t think we would put that on our website. Not yet. Maybe we get to that point, but it’s definitely available for interested people.
Mark Gartner:
Okay. And how would somebody get that from you? Just go to the website and ask to speak to you?
Greg Alexander:
Absolutely. Just e-mail me, you know, Garner dot com.
Mark Gartner:
Okay, fantastic. All right. Well, we try to keep these podcasts short. We’re at the 15-minute mark. So we’re gonna end it here. But a couple of calls to action. So, if you’re a member of Collective 54 and this idea of thematic investing is of interest to you, and you want to learn more about how people like Mark think about making acquisitions, look for the meeting invitation that will come out and attend Mark’s private member Q&A, which will be one hour in length and you’ll be able to ask your questions directly to him. If you’re not a member and you want to become one, go to collective54.com and fill out an application. Someone will get in contact with you. And if you don’t want to do either of those two things, you just want to consume some more content, check out my book, “The Boutique: How to Start, Scale, and Sell a Professional Services Firm” written by yours truly. You can find that on Amazon. But with that, Mark, thanks a bunch. This was very educational as always and entertaining, and I look forward to the follow-up session.
Note: This transcript was generated by Gong.