Justin Ishbia - Lessons from Acquiring 586 Companies [Invest Like the Best, REPLAY]

I've followed your show for years and am so impressed with what you've built. You have a best-in-class audience, and I'm showing every part of it to create enterprise value as a system. No single person creates a star. Our view has always been to create a system, a machine, a process that yields differentiated results and outcomes. I was raised to look for opportunities where others aren't. My view is that the last inefficient part of the private market ecosystem is the microcap sector, which is where we focus our efforts. We define these businesses as having sub-$10 million EBITDA and investment in order.

It wasn't just me; my partners Ryan Kelly, Mike Cooper, and John Henn were also involved. The four of us were young when we started. I was 31, and they were 29, 28, and 27. We were essentially at an associate level. Originally, Ryan was at Water Street, and I was at Valoreci Partners. We would often find attractive deals in specific sectors and present them to our bosses, suggesting a rollup opportunity. However, the response was consistently, "Interesting, but you're one of my X number deal guys. We have to deploy X million dollars per year. It doesn't make sense for us to do that." Essentially, I repeatedly heard that no one was investing in that part of the market. In private equity, if you're good, you raise a bigger fund. If you're not, you wash out. Nobody stays small long-term. So, we decided to create a microcap franchise that would remain small for the long term.

Our average gross cash-on-cash return has been seven times, with a 72% cash-on-cash IRR. We've never had a deal lower than three times gross cash-on-cash; our median is 5.5 times. This translates to a 50s IRR, meaning 70s gross and 50s net. While this isn't sustainable forever, these are our historical results. This ecosystem consistently produces a strong risk-adjusted return profile. However, it's challenging to maintain this as you grow. When you're small, it's manageable, but as you raise larger funds, it becomes difficult to continue doing smaller deals. Your vice president also expects to become a principal, then a partner, adding to this challenge.

I wish I could say I was smart enough to plan this from the start, but I got a little lucky. Our strength lies in the sheer volume of transactions we handle. This creates an ecosystem and attracts many young professionals to ShoreCore Capital. It allows us to have numerous executives involved, repeatedly utilizing their expertise and working with individuals who run relatively small businesses. I believe the next decade of private equity will be defined by operational excellence, so we heavily emphasize operations. We have approximately 150 full-time employees at ShoreCore Capital, with over half being operations leaders. When acquiring a relatively small business from a well-intentioned founder, they often leave many inefficiencies on the table, as they may not want to take certain risks.

I build a board like a basketball team. I don't want five point guards; I want a point guard, a power forward, and a center. In traditional private company investing, I used to invest in small companies, typically around $20,000 to $50,000. Often, the board, which usually had no relevance or importance, was primarily for the money. Someone might invest half a million dollars and demand a board seat. That never happens for us. We seek out what we call the "Mount Rushmore" of an industry. For example, in the veterinary industry, I want to identify who, by industry standards and reputation, is considered best in class.

It comes down to finding first-time CEOs with early career energy. Are there enough high-quality individuals who can scale to the next level? I agree with that. Internally, we prefer a homegrown approach. Six years ago, we created our CXO program, recruiting from top business schools like Stanford, Booth, Kellogg, Harvard, Wharton, Vanderbilt, and Notre Dame. We hire these individuals to come to Shoreline Capital as chiefs of staff. They then spend four or five years at one of our portfolio companies. If they excel, we promise to back them next. We have a unique, dynamic approach. I'd be lying if I said we'd put a 31-year-old in charge of a $1.3 billion revenue business. However, my average business is $18 million in revenue when acquired. I absolutely would make a 31-year-old a first-time CEO if they have a strong track record.

I believe stacking unfair advantages is crucial. How do we achieve this? Our market cap includes funds in Healthcare, Food and Beverage, Business Services, and Industrials. That's one product. Real estate is a different product, and next year, the Healthcare Advantage Fund will be another. I tell our LPs and team members at Short Capital that I will only add a new product if two conditions are met. First, we must have an unfair advantage, meaning the odds of success are tilted in our favor due to inherent dynamics. Second, it must be a health-based business. For example, with real estate, we have a real estate fund. We were acquiring so many veterinary businesses—now several hundred—that we accumulated numerous sale-leasebacks, which slowed down deals and caused problems for us.

We have 150 full-time employees. No vice president, principal, or partner has ever left Short Capital. Associates may leave for business school but often return. We have about 43 or 44 VPs, and none of them have ever left. This reflects our core philosophy. It can be challenging for a 35-year-old to see a 46-year-old founder and wonder about their own advancement. However, our different verticals—healthcare, food and beverage, business services, and industrials—offer opportunities. For example, my most talented healthcare VPs became principals in my business fund, and the same happened in industrials. This creates a 'waterfall' effect, allowing homegrown talent to move into new verticals. My dad always taught me to treat people well. He emphasized two things: "Pay market compensation or slightly above market. Most importantly, people don't quit their friends." My job is to foster an environment where they build strong relationships with each other.