Jonathan Pototschnik: The idea that you don't run a process blows my mind. In my opinion, the transaction is free if you run a process.
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Patrick Baldwin: Paul, this was a long interview with Jonathan Pototschnik. Without further ado, let's welcome Jonathan Pototschnik, lawn care millionaire, into The Boardroom.
Paul Giannamore: Let's do this, Patrick.
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Patrick Baldwin: Jonathan Pototschnik, welcome to The Boardroom.
Jonathan Pototschnik: Good to see you. Thanks for having me.
Paul Giannamore: Is it true, Patrick? Do we have another Texan in The Boardroom?
Patrick Baldwin: Yes, sir, we do. Yeehaw. How's that?
Paul Giannamore: Patrick's been stacking the deck over here with a lot of Texans.
Patrick Baldwin: Heck yeah.
Jonathan Pototschnik: They're all moving here so that's where they come from.
Paul Giannamore: Exactly. Jonathan, you're in Dallas Metro. Is that where you live?
Jonathan Pototschnik: Yeah. I think of me as twenty miles north of Dallas.
Paul Giannamore: Are you from there originally?
Jonathan Pototschnik: Yeah.
Paul Giannamore: You don't sound funny though when you talk.
Jonathan Pototschnik: I appreciate that. I've heard that before, I'll take it.
Patrick Baldwin: Do I?
Jonathan Pototschnik: Yes.
Paul Giannamore: You do.
Patrick Baldwin: Y'all have fun. Be here if you need me.
Paul Giannamore: Patrick, you're stacking The Buzz with Texans. Why'd you bring your boy, Jonathan, in today?
Patrick Baldwin: We go way back in this case. Jonathan had a company called Service Autopilot, a software, the CRM. Lo and behold, Bobby and I were frustrated not having a way to manage the business from the field. Service Autopilot, forward-thinking, fortunately, or unfortunately, was big in the lawn care space but hadn't cracked the whole way the pest control business was built. Our relationship was built on trying to figure out how to get Service Autopilot to work for more of a pest route-based industry. We go back to that. We had a lot of needs and support over the years. Also, has a background in the green space, and he owns a pest and lawn company fast forward to today. We got a lot to cover.
Jonathan Pototschnik: That's about how I remember it. I spent a lot of time on the phone with you.
Patrick Baldwin: Sorry. We're somehow still friends.
Jonathan Pototschnik: We are.
Paul Giannamore: Jonathan, you built Service Autopilot and I guess you sold it.
Jonathan Pototschnik: I sold it. I'm still on the cap table but I sold a majority stake in it.
Paul Giannamore: How'd you get into that?
Jonathan Pototschnik: I started out mowing lawns when I was 14, I wanted to make money. I knew I wanted to work for myself but, at the same time, I theorized that the world was going towards technology. I decided to get a degree in computer information systems even though I never wanted to use it, I just wanted to get myself in that direction. I always thought I was going to be in software. My first real business when I was in my probably early twenties was a software company. After two years, we had blown through all our savings. We were essentially working on a problem that was a little too difficult without funding and the idea of getting funding never even crossed our minds.
The reason software is that when that business fell apart and we closed it down, I accidentally ended up in the service businesses, that's not what I was intending to do. I always wanted to get back to technology and it just took me a long time to get there. When I finally got back, it was because I had these now service businesses that had a lot of challenges in management and a lot of pain and I couldn't find a technology platform that could run them so I believe there was an opportunity.
Paul Giannamore: What years were this when you started this?
Jonathan Pototschnik: It was a real business effective beginning of 2010. We had brainstormed ideas going back to 2008 but we got distracted building a healthcare software company or application for another group. The real kickoff was right there at the beginning of 2010.
Paul Giannamore: Do you know how to build software yourself?
Jonathan Pototschnik: I did up until about 2008. What happened around 2002 or 2003 is when we threw in the towel on our first software company. I was writing the front end of the software back then. I never wanted to write code, I just thought that's a skill you should have, it's valuable. I found I needed it, it was useful. I was writing the front end and my business partner was writing the back end of that technology.
When everything fell apart, I had two little boys and a wife and she was a stay home mom because she had quit teaching because we had our first son, and I didn't know what to do but I wasn't going to get a job so I started doing tech consulting. I did contract programming among other things. I did that up until about 2008. In 2008, I stopped writing all code. For example, on Service Autopilot, I never wrote a line of code. I don't think I have that skill anymore. At one time, it served me very well.
Paul Giannamore: You're saying that I could found a software company tomorrow knowing absolutely nothing about code. Is that a recommended course of action or should I be a coder?
Jonathan Pototschnik: No. I'll give you an example. My business partner, John, is arguably one of the best developers I've ever met, and everybody who ever worked with us would say the same thing. I partnered with him the first time and it didn't work. The second time, we finally got back together. My biggest fear with him is he was such a good developer and he liked writing code so much, I didn't think he could transition to a CTO-type role. It was hard for him but he did it and he did it successfully. Generally, working with a developer isn't necessarily a great path because most can't transition. Now you've got a guy in an equity position, probably a meaningful equity position, that can contribute let's call it a $300,000 a year role. That's not a good trade. That's one problem.
What I do suggest if you wanted to start a software company is that you partner with somebody that understands code and it's your biggest most important asset outside of your client list. It's imperative that technology is being built correctly. You'll pay for it in the long term if you have any form of success in size. It's worth having somebody in a seat with you whether they're an equity holder or somebody you trust that can make sure the code is being built technically correct.
Paul Giannamore: I have a buddy who didn't come from a software background and wanted to do that and then ended up going to night school classes to do code and I'm like, “What are you doing? Are you going to write code yourself?” He said, “No, but I need to understand what the developers are talking about.”
Jonathan Pototschnik: I will say that did serve me well. Tech had changed so much but I could sit in the scrum meetings and the demo meetings and I could generally keep up with what was going on and that was a value. One of the most important things I ever did was get my degree in technology. Even though I'm highly anti-college and anti-degree, I feel that it was maybe one of the most important things at the time. Today, you can learn no skills without going to college. At that time, I probably wouldn't have done it otherwise. I wouldn't have sat down and spent the time to learn it. It also helps a person think in terms of process. You have to think about process and flow and that's valuable programming for the mind.
Paul Giannamore: What was it about field service that attracted you to that aspect? You were like, “We're going to build a software company and we should do a field service software.” How did that come about?
Jonathan Pototschnik: John, who was my business partner in Service Autopilot, was my business partner in that first company. The first company didn't make it. We went in different directions. He stayed in technology working for companies and doing a lot of contract work as well. He was always coming to me with ideas that had nothing to do with field service. Field service was never a criteria. He had a million ideas.
For whatever reason, we were always in the wrong place. I was in the middle of something, I didn't have the time, or I didn't love the idea. We were never quite in the same place. Field service was the first time that I had experienced so much pain and I had a tremendous conviction that if you want to build a business that has a significant client count and has a lot of moving parts, meaning transactions, be it, phone calls, to-dos, jobs scheduled, invoices generated, etc., there's not a great application.
Also, the second most important skill I ever learned was marketing and I didn't see any solutions out there that felt very marketing minded in terms of helping you grow your organization. I thought we could bring all of that together. To answer your question, I thought there was a huge opportunity because a company of any size that has any amount of money had tremendous pain and we could solve that pain. That's what got us interested in field service. It wasn't so much that I had some genius thesis three years earlier and said, “This is the next market that's going to have a big trend upward. We need to jump on it.” It wasn't that, it's just where I happened to see the opportunity at the time.
Paul Giannamore: I see. If we talk about Service Autopilot, it was largely focused on the green industry.
Jonathan Pototschnik: Yes. That was not the plan. The plan was, putting your marketing hat on, who has all the money? The guys with the money I thought were the HVAC guys and plumbing guys. The second part of solving what I'll call demand or the best kind of demand, the demand I want to serve, is who has the money? Second, who has tremendous pain? I felt a lot of pain came from transaction volume as I've alluded to.
As an example, a plumber or an HVAC tech might go out and do 1 job, 2 jobs, or 3 jobs a day, they do a small number of jobs. That could be kept in a notepad or a calendar. It’s not terribly painful to manage and, frankly, not terribly difficult to write the estimates and not terribly difficult to generate the billing. It’s not fun but not terrible.
Contrast that fertilization weed control, in a market where you have max route density with a lot of small properties, obviously, that means close together, you could run 30-plus stops a day, and you just start thinking about that math. Thirty stops a day starts to get hard to schedule, hard to route, hard to bill, lots of phone calls, etc. What we ended up doing was saying we think pain is more important in this case than dollars because we thought we could move upmarket and that's how we ended up going after the outdoor services space. That's how I met Patrick.
Paul Giannamore: You mean it had to do with the pain?
Jonathan Pototschnik: Yeah, he was having pain.
Paul Giannamore: Therefore you were having pain after meeting him.
Jonathan Pototschnik: It created a lot of pain for us as well. What happened back in the day was we were unique and we would get all these companies that had nothing to do with outdoor services. we incorrectly believe, “Give us a couple of years, we'll be able to serve all these verticals.” Our theory was we'll start outdoor services, we'll niche down, we'll get traction, and then we'll scale up into the other verticals that have the money. The reality is we never made it back to HVAC, never made it back to plumbing, never made it to electrical, and barely made it to pest. We weren't a leader in pest. We didn't deserve to be a leader in pest. We kept going deeper and deeper in the green space.
Even more than that, it turned out that we went deep into the residential green space. We had commercial. We had the design, build, and construction side. We were one of the best solutions, maybe in the top two in that space, but we weren't the best but we owned the maintenance space. When we exited the business, about 80% of our clients were outdoor and maybe 15% were in other verticals, but we only focused on the outdoor space.
Paul Giannamore: You had the desire to get into other verticals but as you went deeper and deeper into the green space, it made sense to stay there.
Jonathan Pototschnik: It did. Most readers can probably understand this analogy. Your developers, while they're not designing the technology per se, they're learning these industries, and they understand it. They've got knowledge that's of value. Your customer support team is trained to use the keywords and the right language. Your sales team is trained. Your marketing is all written. Everything has been built around these verticals and so it's easy to say, “I'm going to add another vertical.” If you enhance the technology but you've got the entire other side of the org that has to come up to speed with it, training material, and sales, it's a big undertaking.
What would generally happen is when we looked at the opportunity in another space and said, “We could go capture X or we could keep going deeper where we're at now and we could get Y. We might as well keep going deeper.” I swear we had that conversation about every year, “Next year, we're going to do this,” and then you get to next year, it's like, “We should keep doing what we're doing.” That's how we got trapped. Trapped is the wrong word, it worked out great, but that's how we ended up where we ended up.
Paul Giannamore: It makes total absolute sense. You get 100 additional clients and you either do it in the industry that you know well. If you do it outside of that, if you get that additional 100 clients, it creates a lot of organizational chaos and additional learning requirements. What was it that caused you to exit or at least exit a substantial majority of the business?
Jonathan Pototschnik: Several things. I had no intent to exit. We wanted to keep going. The business was growing really quickly. I was constantly being hounded by private equity and I had been for years and ignored the majority of it. Every once in a while, I take an investment bank call or a private equity call but I didn't care to be distracted by that. I was aware of the opportunity. One of our competitors, Real Green, exited to Serent Capital. I heard the rumor of the number and I thought, “That's a pretty rich valuation.”
In my mind, there were a couple of factors. One, valuations are pretty rich. Boy, was I too early if only had waited two more years. I thought they were pretty rich. I thought there was a good opportunity here. I had wondered if valuations compressed, multiples compress, maybe we get roughly the same valuation for three more years of building. That's speculation. That wasn't the big factor as one.
Another one is in the software space. People don't talk about this. If you're of any significance, there is a major security element. We were spending a tremendous amount of money on security and we always got attacked. Anybody that is of the size that says they're not is lying. There's always that thing in the back of your mind. I've got a pretty sizable amount of my net worth tied up in this thing and we never raised capital and I never even had a line of credit.
We built as we could and grew a successful business but we weren't financially backed by anybody. There was this thing in the back of your mind, “I've got $5 million credit cards in my system.” If you run the math on what it costs per credit card if you get hacked, that's a scary number. We weren't storing the credit card number in our system. We were doing this thing called tokenization.
My point is you start thinking about some of these things. I got a lot of my net worth in this thing. There is always a security risk. We've never had any problems to this date. We've never had any problems but it's something you fight. There are little things like that. There are a couple of other things that said, “I'm going to look at the market.”
I've come to like the private equity industry. People laugh at me, my friends that know me. I ended up probably meeting with 40 private equity companies. If you'd send your partner down to see me, I'll have lunch with you. I figured even if I don't do a transaction, I get to learn. I met with seven investment banks and I came to conclude I could find a partner and I also came to conclude I could get excited about doing something else. We got our number. It was that simple.
Paul Giannamore: What year did you close that transaction?
Jonathan Pototschnik: August of ‘19. That's where I said it was too early.
Paul Giannamore: November of ’21 would've been ideal.
Jonathan Pototschnik: Who knew what was gonna happen?
Paul Giannamore: As it turns out, probably August of ‘19 is better than August of ‘23.
Jonathan Pototschnik: I agree with that 100% because I still have equity on the table.
Paul Giannamore: It's better being on the front end of that than potentially the back end.
Jonathan Pototschnik: I remind myself that I've never been able to time the markets. I wasn't going to time that one but I'm thankful for how it worked out. It is what it is.
Paul Giannamore: You did this a few years ago. You've rolled some equity. Are you in a board position over there?
Jonathan Pototschnik: No, I'm completely gone now. I left a little quicker than I thought I was going to. I feel like maybe I stuck around longer than many. I exited in August of ‘19 and I believe I gave up the CEO role in April of ‘21. If we didn't have an earnout, we could have left on day one. The reason I stuck around is I wanted to acquire businesses, I wanted to see that side of the transaction. We did our transaction with Advent in Boston.
There was a strategic on the deal, which was a payments company called Clearent that also had, at the time, 1 or 2 other software companies much like ourselves. The other software company was in the HVAC space. The idea was that there was this payments platform surrounded by SaaS software companies. Rolling into let's call it a larger org even though we run these businesses separately, I would learn all these cool things that I hadn't learned.
I'd never lived in a multi-hundred-million-dollar revenue business. I felt like I generally learned most of the stuff that I hadn't seen before pretty fast. It wasn't quite what I thought it would be. It was interesting. I'm not being disparaging whatsoever. It's more that you just do more of what you're already doing. When you get to size and you start building a leadership team, it's just bigger. The effort is about the same, it's just bigger. That was my takeaway.
When the COVID stuff happened, in the early days of Covid, Advent, for example, wanted profitable organizations, quality organizations. When multiples started getting crazy, they said, “We're out of this. We're going to pause.” They were prudent. They paused. We might've been the last transaction before they paused.
I was involved in working on some deals but once they paused, most of my excitement or reason to stick around was gone and so then I moved on. Frankly, when I moved on, there was this other component where we did some coaching back into the green space. I stuck around and did that, just the coaching part. I stuck around for a little bit longer and then we wound that down and I fully moved on. I've been on a sabbatical for almost two years.
Paul Giannamore: It sounds like you ran a full formal sell-side process.
Jonathan Pototschnik: Yeah. We had 27 formal offers. We took three companies through due diligence at the same time with no exclusivity.
Paul Giannamore: What were some of your biggest learnings or takeaways from being a principal in a sell-side process like that?
Jonathan Pototschnik: I was too financially conservative because I had no debt in my life for a decade or more. I ran my businesses that way and I had millions and millions of dollars. I should have applied all my millions of dollars into growth because what they paid in terms of return versus what I get anywhere else is not even living in the same world. I should have spent more heavily. I should have gone deeper from a sales and marketing standpoint, spent more CAC, cost to acquire a client. I should have spent more CAC to get more clients because, in my space, at that time, we were valued on the speed of growth, which we had, and we were valued on top-line revenue.
EBITDA mattered but it frankly didn't matter like it matters today, not even close, but we had that too. If you are getting valued, in my case, based on top-line revenue and speed of growth, let's buy more top-line revenue and speed of growth and I'll pay more for it. A lot of that frankly came from I wasn't planning to do a transaction. If I had said, “I'm going to do a transaction,” in two years, I would've juiced it. I did have enough knowledge to know but that was my biggest misstep. I should have spent way more money to acquire way more clients because of what I would've got in return for them.
Paul Giannamore: Almost every time I do a transaction, the client, after the deal, looks back and says, “I didn't understand how this was all going to work. I didn't understand the metrics necessarily that these acquirers are looking at. Had I known that, I would've run this differently. I was not preparing to do this so I didn’t.” I always say to myself, for business owners, it's important to, if you're not planning on doing something, start to think about that now. I rarely work with anyone who says, “Paul, in five years I'm going to do a deal.” Five years later, he calls me up and says, “I'm ready to do the deal.” It's always very opportunistic. A lot of it's based on the market. Sometimes it's based on somebody getting sick or divorced or some sort of issue.
Jonathan Pototschnik: 100%. I'd second that every day of the week. That's why it's at the top of my learnings. What I'm about to say is absurd but I had never sold a business. I'd been close once but have never sold a business. You talked to a lot of the private equity guys, most of the people I talked to were financial buyers, and very few strategics, frankly, in the market at these valuations even back then. I talk to these individuals and they're like, “It's an efficient market. The price will work itself out. It'll be within 5% or 10%. It'll be roughly about the same across the board.” Using this efficient market argument.
Let me give context. I was trying to decide, “Do I spend millions of dollars in fees with an investment bank to sell the business or do I want to try to run my own process or whatever that might look like?” Because I had so much inbound, I could hypothetically work with these twenty private equity companies. It sounds dumb in my head to say I would've ever considered an alternative to running a process. Rightly so, we decided not to. Eventually, I got smart and I started asking the private equity companies, “When you sell your company, do you ever run a process?” That's amazing, quite a few of them do.
Paul Giannamore: Every one of them does.
Jonathan Pototschnik: That's pretty telling. Everything else we're talking about is nonsense. I remember one private equity company and I'll give them a call out, it was Mainsail. That said, no, you should use an investment bank. They didn't flip that switch in my head, I was going to do it. They were the most sincere about it. I talked to so many. For many, we didn't even have this conversation so I'm not putting down a lot of groups. That's another one that's imperative.
If anybody ever asked me the idea that you don't run a process blows my mind. In my opinion, the transaction is free if you run a process. Yes, if you've got a big company, you'll spend millions of dollars but who cares? It's free. You're going to make enough additional dollars on that transaction to fully pay for that. Not to mention we spent $500,000 on legal at least. On the other side, we spent even more than that.
I didn't know who to work with from a legal standpoint. I had all these questions that if I had tried to do this thing myself, I couldn't simply ask the investment bank, “Who do you recommend?” Piggybacking on that, the investment bank was so ingrained in the market. They had done some field service, not a lot, but a lot of the private equity companies are buyers of a variety of different SaaS software companies or whatever they tend to invest in, or whatever their thesis is.
In my opinion, a good bank, if you want to use a bank to represent the party selling the business, they know how a private equity company tends to react post-deal, and how they tend to work with the founders. They know all these little details and so the number of insights we got. As an example, we had a couple of investment banks at the table that made it to the final eight, and our bank said, “Great companies, but you're kind of a small deal for these guys.”
What does the world look like when you're maybe the smallest deal? There were plenty of other tidbits of that sort. I can't even fathom not running a process. I've been through a process. If I sold another company, I'd run another process. That was a big learning that I had never lived in that world. It was eye-opening and valuable.
Paul Giannamore: It is a gift to a buyer. successful business people that build substantial businesses oftentimes think that their success in building that business is transferable to their success in running a formal process. How hard can it be? I get emails all the time and phone calls. I've met with 50 of these guys. No problem. I talked to a guy who said, “I've met with this private equity firm and that private equity firm and this private equity firm and all these guys here in the pest control space.”
He said, “I had dinner with one of them and we were talking and I said, ‘I'm thinking about hiring an advisor.’ They said, ‘You don't need to do it because it's a relatively small market and it's pretty efficient. We're all going to go all in on this and there's not a lot of room.’” He asked the same question that you did. He said, “When you guys sell your portfolio companies, do you hire investment bankers?” They looked at each other and said, “We're a little bit different than you. That's how we have to do things.” Unless you've been through it, it's hard to understand this, right, Jonathan?
Jonathan Pototschnik: It is. I empathize with anyone. I gave this a lot of thought. I was fortunate the business was in a position where we had a good leadership team so I could be gone and meet with these groups. I was in a fortunate position and so I got to put the thought into it. The swing from the first offer to close was $36 million. I didn't pay any work less $36 million in fees. I would've negotiated so it wouldn't have been a $36 million spread if I'd ran the process myself, but it would've been a big number.
The other thing I'd say is never could I have predicted this but when you get down, it became a little contentious towards the end. We had 8 we kicked out everybody but 2 or 3 wanted back in desperately. I got a few threats, “If you don't do the deal right now, I'm never going to talk to you again.” I get a couple things like that. I would push them back towards the investment bank. Letting the investment bank be the bad guy, if that's the right word to use. Be the bad guy and have the hard conversations. Post-deal, I thought that's valuable because post-transaction, you're going to work with this acquirer, and I want the best possible relationship I can.
If I can shift some of the difficult contentious right or wrong conversations to the individual group company representing me, I think that's a value add. I remember when we were down to the wire and we had three deals that I could have gone. One didn't take my highest offer but the other two were right there. I'll never frankly know if I made the right decision because I liked boats so much. We were pushing and pushing. We got to a point where it was almost as though they were saying, “You guys are about to piss us off,” and you believed it versus it being a line. I wouldn't have got that far. I would've backed down way sooner. None of that harmed my relationship post-deal.
Paul Giannamore: You're right, preserving the relationship is important, especially if you're going to work with these people. As you probably realized in the deal process, one of the biggest deal killers is not financial. It comes down to egos on both sides of the table and it's easy to take things personally. It's a lot easier for somebody to step in the middle there, an advisor, and take a lot of that heat.
Jonathan Pototschnik: It was exhausting because three companies taking you through due diligence is freaking exhausting but it was worth it.
Paul Giannamore: You got that deal done in ‘19. You've been on a sabbatical. What's going on in the present day?
Jonathan Pototschnik: Travel. It happened magically, this was not planned, coincide with, I've got two kids, my youngest going to college, and my oldest has been pretty much self-sufficient since when he was 16. He doesn't need us in any way. It coincided with we did the deal, I stuck around, and he went to college in ’22.
We travel constantly. We had traveled a lot prior to ever doing this deal and take our boys to a lot of places. We got to a place where the boys never wanted to see another waterfall and never wanted to see another church, “If it's not snowboarding, we have no interest. Europe's not that exciting.” That was their attitude. We had all these month-long plus trips that we're never going to get to take the boys on. We've been filling our time with that.
Paul Giannamore: In late ‘21, you started traveling. Where'd you go?
Jonathan Pototschnik: I've been to Vietnam, Cambodia, Thailand, Portugal, Italy, England, and Mexico many times. We spent a lot of time in Telluride, Costa Rica, and there's going to be more. I'm leaving in a couple of weeks for Greece or Slovenia and Croatia. After that, New Zealand and Australia. I'm missing some other stuff but that's some of the list.
Paul Giannamore: You guys were doing this multi-month at a time.
Jonathan Pototschnik: Five weeks. It's been good. We love to travel but I love business more. My favorite people are in the business world, they're all entrepreneurs, it’s those people that move the world forward, and I need to live in that world to be a happy person in life. It’s not that I'm unhappy otherwise but those are all the conversations. Send me to a party that's not with entrepreneurs and people moving things forward, I don't even know what to talk to you about.
Paul Giannamore: If I were traveling for five weeks and not doing anything other than being present in the moment and traveling, which is something that I would love to be able to do, I don't know that I'd be able to do it.
Jonathan Pototschnik: It took me a while to wind down. Patrick might have asked me this when we had lunch, he's like, “Do you regret selling?” From a financial standpoint, it's still way too soon. From an experienced standpoint, having gone through the process, having had this sabbatical, and getting excited about something else, I don't regret it. It's purely monetary is the only reason. I am incredibly thankful for this sabbatical, this break I took. Whether 90 days gets you there or not, I don't know, but that'd be better than what 99.99% of the world does. It'd be pretty good.
Patrick Baldwin: Jonathan, I don't think you sold too early. Now this gives you more time to do it again.
Jonathan Pototschnik: Yeah.
Patrick Baldwin: What is it? What's next?
Jonathan Pototschnik: I don't know. One of the best experiences I've ever had was building any type of authority brand, it's one of the single most valuable acts or places you can invest your time so I'm going to start there. I'll rebuild my personal brand, it opens lots of doors, and you meet a lot of people, it's incredibly valuable. The thing that I've been most passionate about is whether or not I do it immediately, the thing my wife wants me to do is I'm pretty passionate about high school and college-aged kids becoming entrepreneurs.
Entrepreneur is the game that changes you more than any other, that's my argument. It makes you grow into a specific kind of person that shows up differently in your family, your kids, your spouse, and your team. There are all these skills and this mindset if you're going to build anything of any size that you have to develop and cultivate in yourself. You get that, you're forced to do it through entrepreneurship. Those that sort of rise up that are young and express interest in this, how can you help them get there more quickly and show them the path because it's a game changer for the rest of their life?
Downstream, if they do it right, they're an example to their kids, their friends, and many other people. I'm super passionate about that. For sure, there will be some means or some way in which I work that into whatever I do next. The final thing I'd say is I like working through other individuals. While I feel like I maybe need to be CEO to move the thing forward at the speed that I want to move it forward in, I'd give up too many things so I'd like to maybe work with 2, 3, or 4 companies where I place money and place time to work through the CEO and help them and coach them.
I don't want to give up all the freedom I’ve gained. I’d give up a lot of freedom to be the leader of the company because you're the example. It's one thing to say, “I want everybody to work hard. If you could work about 60 hours a week and you could go all in, ignore the little fact that I'm going to be over in London for the next three weeks. After that, I'm going to be somewhere else.”
It's like telling your kids not to do something but you do that. They don't hear the words, they see the activity. I feel that to be a great leader, to be a strong CEO that builds a great organization, you have to go to a battle with the team. I don’t know if I want to go to battle with the team in quite the way I have historically. I'd like to help the CEO of the business go to battle with the team and be an example.
Patrick Baldwin: That makes sense. I love it. Going back to Service Autopilot, you were focused on the green space and the way lawn mowing at its simplest form, that maintenance, that's a weekly recurrence. Pest control has this work quarter-based system and it could recur weekly, biweekly, semi-monthly, monthly, bimonthly, quarterly, semi-annual, or annual. It was one-times all over the board and y'all made a decision to then almost bifurcate your system. If I remember right, it was almost like there are two sides of Service Autopilot. Is that a decision that you regret or are the things that you wish you would've said no to in terms of building out Service Autopilot?
Jonathan Pototschnik: It was the right call, wrong execution. Every year you go into planning or thinking about what's upcoming and you say, “Where should we allocate time? What's the opportunity cost of doing X versus Y?” You keep doing the same thing you're doing. We built that work order system with the intent to spread out into these vertical markets that a route sheet dispatch board wasn't the right interface for them.
We did 50% of the work and we never did the other 50%. It was because, as I said, when you say what's the best course of action knowing what we now know for next year, we never reinvested or continue to invest in that work order side of the system. From a strategic standpoint, if you have the resources, call it money and time, that is the strategy based on what I've experienced. If I had a better understanding of what the reality of resources and time would've been, I wouldn't have done that.
Patrick Baldwin: You sold in 2019 and ran it till 2021. Are there features that were still on the table that you're like, “I wish I had more resources.”
Jonathan Pototschnik: There are so many. Full API is the single most important. It hasn't been done, imperative. I wouldn't even start a software company without making the thing a full API. We made the right call in that there were two massive decisions, do you build an automation system or do you build the system into an API in conjunction with all the other functionality you built?
We made the bet on automations, it was the right bet because of what's happened from a revenue standpoint inside the organization. When a buyer buys, the vast majority all buy the automation system. If you looked at churn, when we exited the business, I had 128% revenue retention if you were buying the automation side and I had 101% revenue retention if you are buying the pro membership without the automation.
I add 82% retention from just a pure logo standpoint, if I remember correctly, on the Pro. I had 99% retention on the automation. Economically, it was arguably the single best decision because it allowed us to drive down churn and expand the value of every client in a meaningful way. I don't know if an API would've quite accomplished that, it would in the long term but not so quickly.
We made the right decision to build automations first and second is build API. We exited the business before the API got to where it needed to be and that project died. There's a chance it comes back or may be in process and I've not been told but that would be the answer to your question. That's the one that is imperative and that will make that system near impossible to leave if they accomplish that.
Patrick Baldwin: What would an API do if you were to build that out?
Jonathan Pototschnik: Here's how it always works. You have a truck whose starter breaks on it, you're pissed, you call me, and it's now my problem, “The starter broke, if you guys only had maintenance tracking. If you had maintenance tracking the software, it'd solve all my problems. We would be more profitable and the business would be better. I got to have maintenance tracking.” John and I are like, “Crap, maybe they need maintenance tracking. We want to solve your pain. We want to solve your problems.”
We would get distracted. We'd eventually come back but we'd get distracted thinking about, “Maybe this is the new most important task.” I'm being a little dramatic here but that's real, that's how we felt internally. We felt pain, “We got to solve this problem for our members.” Somewhere along the way, Saturday night, John and I are drawing up maintenance tracking. It doesn't ever get built but we're drawing maintenance tracking because we think we might build that or like, “We'll get to this next year. We're motivated. Let's draw this up, a design.”
With an API, you say, “We are not in the business of maintenance tracking but we have the data and we will talk to whatever your favorite maintenance tracking system is.” What it does is it allows us to not get caught up building all the functionality and feature and trying to solve every pain point the client has and staying focused on what you're the absolute best at. That analogy extends itself into other businesses. If you're great, your client is always asking you to solve all their problems but you could do that to your detriment.
The API allowed us, one, to not be in the business of trying to solve every problem. Two, when a client will use maintenance tracking, and connects maintenance tracking to our software, they connect some email marketing system I, and then they connect something else, whenever they wanna leave us, they have to disconnect three other software systems at the same time. You're locking them in at an ever greater level. The idea that they're going to change 4 or 5 systems now when they leave us to go elsewhere, they're not going to do that. They'll blow up their operations so they're stuck. I mean stuck in the best kind of way if you're running a good organization.
Paul Giannamore: Switching cost is very high.
Jonathan Pototschnik: That's a better way to phrase that.
Patrick Baldwin: I feel like as you feel into those phone calls, you were almost a therapist and counselor, everything rolls downhill and you're ready for the call.
Jonathan Pototschnik: It was a lot. It was the hardest business I've ever built. It’s the one I've learned the most but the hardest business I've ever built.
Patrick Baldwin: What questions are owners not asking as they're looking to switch software? It’s like, “I had downtime today. I throw my hands in the air. I'm fed up with my current solution.”
Jonathan Pototschnik: Security and redundancy. We had built a big outbound sales team. Back in the day, probably when you met me, I'd give you an hour-and-a-half-long demo. I'd solve every one of your problems. Somewhere along the way, it was like, “You just got to figure out the top three problems. You gotta solve those problems. They'll buy the software and it works. Our system could solve so many problems, an unlimited number of problems.”
What are the top three with whomever you're talking to? Solve those pain points, there's a high probability they'll buy. Maybe you need to dig deeper. Maybe you need to do the top three with somebody in a different seat and different role inside the org but that's a strategy that works. If you think about that, you came to the table and said, “I've got this scheduling problem and what I don't like about my scheduling solution is I don't love the way it routes.”
Routing is an important piece of software but it's frankly 3% of a scheduling system, and that was the hot button that sold you. What happens when there are weather delays? How do you manage chemicals? How do you handle job notes? How do you make sure that a job note in the field doesn't make it to the client where they see the job? I could list hundreds of variables of that sort. You made your decision on routing and you didn't realize all the stuff you gave up or don't have when you moved to this system. That's an example of how difficult it is.
I would encourage companies to go through a way more in-depth process. They won't do it because what you got to do is you gotta look at the processes internally inside your organization and say, “These are the things that make our company work special, unique, get a great NPS score, or whatever the thing is.” You got to list those things out. I'll use weather delays. At my company, we do 11,000 jobs a week or whatever it is. We have 11,000 clients. This is a different company.
If there's weather, how do I tell 11,000 people that their shift schedule has shifted? That would make it on my little list of important activities that are happening inside our organization and there are about a hundred of those things. You need to watch your team or have your team members say, “These are non-negotiable things. We have to be able to do this. This is what makes us, us.” You then go look for technology.
Of course, you'll make concessions here or there but that's one. This is the one that's difficult, are your data centers in different geographic areas? In a SaaS software situation now, you have all your data, which is arguably one of the single most valuable things you have inside your organization, it's the life of your business. Imagine tomorrow you can't get your scheduling for 100 crews, 100 techs, a full-on disaster.
You talk to a software company and the software company says, “We hardly ever go down. We don't go down.” Great. What happens if there's a power grid issue? What happens if there's a data center issue? Back in the early days of Service Autopilot, we were using Rackspace. This is the beginning. This is the first couple of months. We were using Rackspace and we had a lot of experience with Rackspace.
Rackspace is a phenomenal provider or at least they were at the time. there had been a major accident just outside their facility. The power, if I remember correctly, coming in failed. No problem, they have backups, their backups all failed, the power didn't kick on, and the servers all went down. I have picked the right provider and they are spending the money. It's expensive, it's hundreds of thousands to millions of bucks a year to do what I'm about to say. You'll automatically flip within seconds or minutes to a different data center in a completely different zone. That's imperative.
When we were looking at acquisitions and I looked at a couple in the pest control space back after I did the deal, a few ticked this box and it was horrifying. I was saying in the meetings, “This is a massive risk. How long is it going to take us to build redundancy?” Let’s call it a $100 million transaction, there's a risk on a $100 million transaction for a year until we get redundancy. It's that thing.
One more is security. If you are dealing with a lot of transactions and you're dealing with a lot of payments, meaning that whoever is somehow looking at your website, like, “This company might store financial data. They deal in money.” You're a target. What is that company doing to navigate the never-ending attacks on your organization trying to get into your database? That's 3 of 50 things you'd think about but those are the 80-20 of it, those are some of the biggest ones.
Patrick Baldwin: About security and payments, there's a side of the business on the SaaS business I didn't even think about, behind the curtain, you've got this payment processor. In terms of one, in migration, I feel at times I was held hostage like switching from software to software. I don't remember who but I remember it's going to cost thousands of dollars to get your credit card data and your customer's credit cards out of the system into another system. We've seen another software here do it in-house. What do I not know about all these payments that are running behind the scenes in SaaS softwares?
Jonathan Pototschnik: Whenever you pay 3% or whatever that number is, your payments company is getting a tiny little bit of that. MasterCard or Visa are getting the majority but they still have room, they have margin and they make a lot of money. A lot of times, you'll think, “I pay them 3%. They're getting 3%.” They're not getting anywhere close to 3%. If you're negotiating, know going into that, you're probably not going to get quite what you're imagining you're going to get because they don't have it. There'll be no point in winning your account.
When we started Service Autopilot, it was a different world. Now, if you are even a halfway intelligent software developer, you're not storing any credit card data inside your software system. Most of the small startups are using Stripe and Stripe has resolved that problem. We didn't use Stripe but it's called Tokenization. Your credit card data is stored elsewhere. It’s stored at the payments company. It's not stored in the database of your CRM, ERP, or whatever system you're using.
Generally, you're fairly safe there now. That was not the case back when you and I were working together. We always did Tokenization but a lot of our compares at the time didn't. What tends to be the biggest challenge now is, one, maybe negotiating your rates from time to time, and then two, it would be that if you do move providers, how do you get those credit cards out?
You might've been using Authorized.net back in the day, I don't recall. Authorized.net didn't release the credit cards and that's one of the reasons we left. I don't know if that's changed today but it's one of the biggest reasons why we left Authorized.net. We thought it was a terrible situation for our members. We called our clients members. That's going into it. If your software provider offers multiple payment options, you should consider asking the question, “If, for whatever reason, this doesn't work out, how do I get my credit cards back and how much will it cost?” Maybe negotiate what it'll cost at the front of the deal.
Patrick Baldwin: Talking about working with the team and managing the team, I'm familiar with DiSC. When we were having lunch, you mentioned Kolbe. I know of Kathy Kolbe. I have not dug into it but you use that to help get your team on the same page. Can you tell me how you use Kolbe at the business?
Jonathan Pototschnik: People get pretty passionate about this topic, they're like, “Mine's the best.” “You gotta use Culture Index.” “You gotta use DiSC.” “You gotta use Myers-Briggs.” People get worked up about this topic. Pick something, learn it, and do it. Keep your team trained on it, implement it, and stick with it. Stick with it is probably my biggest keyword there. I had heard about this at a conference I was at and a guy named Dan Sullivan spoke and he owns a group called Strategic Coach. He mentioned it and then I went to this other event. This is way back before I ever implemented it.
I was at this other event and this guy named Joe Polish mentioned it, I was like, “Huh.” I just kept hearing it and then I heard some other people that were running big organizations mention it, I was like, “That's interesting.” I did nothing with it. When Service Autopilot was 28 people, I decided I want to try to bring Kolbe into this organization. I found this individual in Kansas City, his name is Jason Cupp, and I contacted him.
One of many things he did was Kolbe and so I had him come in and train our team on Kolbe. I had him come back every single year at least once and keep the team up to speed. For me, if I build another company, I would use Kolbe again and the reason is because I know it so well. I read one of Kathy's books. I spent a lot of time with Jason. Jason became a great friend. I asked him lots of questions. I brought him in every year to train the company. It became the fabric of the organization. With four numbers, I can understand how you operate.
Let me give you a marriage analogy. In Kolbe, there are four numbers, they're on a scale of 1 to 10. I'll tell you my numbers, my numbers are 8, 3, 7, and 1. My first number is 8 and my wife is a 4 on that first category. If you are four or more apart in any category, that can create stress, strife, confrontation, and challenge in a relationship, call it work, relationship, or personal relationship.
My wife and I are four or more apart in every category. I live in the future. I like change. I like moving fast. I like facts and details. I like data. I want to make my decisions on data. I don't love to process and I can live in my head. My wife is all process and all procedure. She doesn't care about facts or details, and she doesn't like change and she does not live in the future. Those are just a few things.
A perfect example of our life is she stayed home after our first son was born and quit teaching. We made a deal. I hate cooking. I never ever want to cook, “You cook and I'll clean the dishes.” I still clean the dishes every night to this day. My version of clean dishes is very different than hers. We all finished dinner, I play with the kids, play with the dog, I had an idea, and I do something. Tiffany's idea when she finished dinner is on that checklist in her brain, “Dinner and dishes.” Hard stop and nothing else. We would just argue.
I was like, “Who cares if I clean the dishes twenty minutes later? Who cares? They're going to get done. Have you ever woken up and they're not done?” It's that kind of a thing. I know I'm belaboring this but it is a perfect example of Kolbe because when we both took our Kolbes, it's like, “I've known you for a long time but you were made to be a process person. You operate with a checklist in your brain and when you can't go 1, 2, 3, or 4 in order, it jacks up your world.”
“That's not because you're mean. It's not because you're being a jerk. You're not doing anything on purpose to make my life miserable. That's how you're made.” It gives you this empathy and it gave her empathy for the multitude of things I do that drive her nuts. It was incredibly valuable. We implemented this at work and then we did it personally and it's like, “I understand you. This is who you are.”
Also, we now live in a world where Tiffany is way more flexible in this dishes thing. It's not just one way. She's like, “You'll get it done. I understand how I work now. I'll ignore that. I'll choose to ignore that.” That happens at work. How do you put teams together? How do I not put on a team four people that are going to research, create spreadsheets, and read forever and never execute? How do I not build a team of people that are never going to think about a process and a procedure and they're going to go build whatever they feel like doing today or do work on whatever problem they feel like today?
If I'm constructing a team, how do I put the right people together and have the right skillset? How do I help them all understand, “When I come to you, I don't need to bring 90 pages of facts and details? I need to give you a paragraph summary. If you trust me, we might move forward. If you need a little more information, I've got supporting details.” It teaches you how to communicate with each other inside the organization. I found it to be incredibly valuable to the point that I had a coaching group with 135 individuals in it, I had every one of them take Kolbe.
If I'm now dealing with them, I could look at their Kolbe and understand. You can see today, I give long explanations. I don't know how you guys are wired but if I'm talking to somebody that hates facts and details and long explanations, I need to be careful and be more concise. In a podcast world, you tend to get more listeners that are okay with longer explanations, the long format.
For somebody who cannot stand lots of facts and details are probably not big podcast consumers so that's my example. If I'm dealing with that individual, I need to be more concise than Jonathan is normally going to be. That's why I'm a fan of Kolbe. You learn it, you go deep with it, and you train the team on it, and you make it the fabric of the company. You bring somebody in to talk about it every year, meet with all your new employees, then it becomes something you live. Otherwise, it's a waste of money. It was something that sounds good.
Patrick Baldwin: What are you looking at doing? Do you see yourself reinserting yourself back on the city turf or starting something new?
Jonathan Pototschnik: Both. The guy that runs the company's phenomenal and I absolutely respect him. I would not get in the way. I would simply support him in marketing and recruiting. Recruiting's the single biggest problem in almost every single organization and it's the thing you solve for if you want to grow. Our number one problem has been, it's almost silly to even talk about marketing, and acquiring more clients in a healthy company. You should talk about recruiting and solve that and then work on marketing. I would go in with one purpose and that is to solve recruiting and then work on expansion revenue, selling more back into the base that we've already got. We do that stuff but do it at a much better level.
Patrick Baldwin: And implement Kolbe.
Jonathan Pototschnik: It's down the list, but yeah.
Paul Giannamore: Would you start another software company from scratch?
Jonathan Pototschnik: That's a tough one. If I was starting in the services space, I'd probably buy my way in and then build organically, especially if I'm going to a new market just for speed. Organic growth is cheaper in my opinion. In the software space, the valuations are tough to overcome. I struggle with that one. I've thought about this quite a bit. There are many talented developers out there with pretty good ideas but they're missing the other side of the equation. This is not fair. Anybody can build software. Not anybody can build a brand and authority and sell the thing.
Paul Giannamore: I can't build software.
Jonathan Pototschnik: It's not a fair statement. It's just that I'm making the arguments a big skillset. It's very unfair because the guys that build good software and write good code are awesome, some of my favorite people. If you look around, there's an unlimited number of 16, 17, or 18-year-old kids sitting in bedrooms right now playing video games and writing code, and there's a lot of them. There aren't as many 16-year-old kids sitting around learning direct response marketing and sales and door-knocking to learn how to sell and all this other stuff.
It's a different skillset to take a business from nothing to $10 million. The reason I'm giving you that long answer is to simply say there's an argument if you could find a well-built application that's $500,000 in annual revenue. There's no private equity investing interest in that. Multiples are massively compressed and a much smaller buyer pool. That's interesting, it just gives you a launching-off point. Where I get stuck is I come from the software world and I know you don't want to be cheap.
Entry cost is not the way to make a decision. Great, I can buy this thing for cheap but I will pay for it for the rest of my life because it was architected incorrectly. Or core decisions were made early on to support a market and they were wrong and we got to rebuild it. That's incredibly expensive. It's the argument of you could go buy a bunch of million-dollar businesses or you could buy a great business and the great business is going to be a much better business.
All the other business, you're just going to fix them and they're going to take all your time. It's that argument but I'm using it in this specific to the architecture of the technology. If it's well-built, how do you know, unless you have that skillset, you could be buying something that you'll pay for for the rest of your life. I talked all around about the answer. I didn't say yes or no. My preference would be to go buy something small and build from there. That would be my preference but it's way more difficult than it sounds. It's easy to have that conversation at a cocktail party and say, “This is what I'm going to do,” but the execution of it is way more difficult.
Patrick Baldwin: You've been in and out of a few businesses now, there's been a lot, some success, and some failures. Success notably with Service autopilot, for sure, but even the ones that you've shut down and walked away from. Can you walk me through hard decisions that you've had to make for the betterment of yourself or the betterment of the business?
Jonathan Pototschnik: The first one that always comes to mind is the hardest thing about building a company is letting great people go. It's not incredibly difficult to let a terrible person go.
Paul Giannamore: Sometimes it's really easy.
Jonathan Pototschnik: They're terrible, you need them out of your organization but it still isn't the funnest conversation. Letting the person go that helped you build the thing and work their butt off and is all in and fits the culture and you like them and you care about them but they're not going to get you to the next level, that's the worst part of building a business. I would use all those decisions I've ever made and I have been good at it at times and bad at it times as some of the best and most important decisions I've ever made. That's an area I'd still be growing in.
Right before we started Service Autopilot and we had the idea for Service Autopilot, I was doing this cleaning thing, I was doing the city turf thing, that's my outdoor services business. One of my consulting clients had raised $1 million and brought me in on a deal to build a software healthcare application, which we were building, and they gave us equity in it, and then we were going to start Service Autopilot. I had four things going. I had two little boys, a wife, and I worked. If I didn't work 90 hours a week, I have no idea what I did. I came home at 6:30, we had dinner, the boys went to bed, and I went back to work till 3:00 AM at the house and did it every single night. I pretty much hit a breaking point.
Also, that cleaning company was an overnight business. We cleaned movie theaters in 22 states. It was just all nighttime business and I had to give some stuff up. I would say one of the hardest decisions was I walked away from my equity in the cleaning company and the healthcare software company and bet on my other two things. That was difficult but I am incredibly thankful that I made that decision, I made the right bet.
Paul Giannamore: Did your wife ever tell you the only thing you care about is work?
Jonathan Pototschnik: She may not have verbalized it quite that way but I would be fairly clear on the subject.
Paul Giannamore: I deal with a lot of these guys due to my line of business that charged hard their whole life and then they sell a business and they find themselves in a position like yours and then they get completely lost. A lot of these guys go through, what I would classify, although I'm not a psychologist, as clinical depression.
Jonathan Pototschnik: That's what I've heard.
Paul Giannamore: It's a real affliction because you feel like you don't have a purpose. Guys who are entrepreneurs and get a lot of joy out of building something, that's their sport. They're not watching the Cowboys play on the weekend, they don't care about that. They want to do deals and get stuff done. I can see how that happens. I always tell every one of our clients to take at least six months off. If you can pull a year off, that's great, before you start dumping tens of millions of dollars into some new venture because there's just such that magnetic pull to get back into the action. I feel like a lot of these guys that do it too soon make serious mistakes because they want to get back into something.
Jonathan Pototschnik: I 100% agree. I've seen that with friends I know and meeting other people. For years, I've been in this group, it's a financial group. I hear the stories in there directly or I hear them about other people. I have arrived at the belief that the vast majority of Angel deals and privately funded deals are massive failures. It's a small number that work and a small number of people have success. To your point, those that do them immediately and start spreading money around, you see them one time, you're like, “It's going great.” They don't have to market on anything. You see them another time, “We're closing down the business.” It’s like, “I thought it was worth $10 million two months ago?” It’s like, “No.”
I couldn't agree more. I've taken that to heart. We were talking about what I might do next. I don't know how much exposure you've had to lots of different lines of business or trades but when you think about which trades carry some of the highest gross margins and you can build a sizable organization, meaning there's plenty of volume. Any specific industries come to mind? I know pest control is a solid one, I live in that. Are there any other trades that you're like, “These are real standouts from what I've learned over time.” It could be plumbing, HVAC, septic tank clean-out, or sprinkler systems in your ceiling. Are there any standouts where you think, “These businesses tend to carry exceptional gross margins?”
Paul Giannamore: For me, it's not always just gross margin. When I look at the trades and residential services, one of the things I'm looking at is capital intensity. Is it a capital-light business or not? Understanding capital intensity, if you compare lawn care, for example, with pest control, lawn care is a more capital-intensive business. In order to run a lawn care business, you need a $60,000 truck. Whereas in pest control, somebody can do it on a moped. You get capital intensity.
I'm always thinking about the cost of customer acquisition, the lifetime value of that customer, and the potential duration of that customer. When I compare, for example, pest versus lawn, lawn has a shorter duration customer. On average, maybe a residential lawn care customer might survive 3 to 4 years. Whereas in pest control, it's typically 7, 8, or 9 years. The gross margins for pest and lawn are relatively similar. Lawn care might have a slightly narrower gross margin profile for the most part.
Jonathan Pototschnik: Chemical cost is a little bit more
Paul Giannamore: Correct. Absolutely. At the end of the day, if you get a customer to survive for 9 years versus 3 years or 4 years, you can compound growth through lower attrition rates. That retention makes a big difference. I think about things from a competitive standpoint. If I take the pest control industry, every financial sponsor that wants to get into pest control always says, “Florida, that's 24/7. That's a bug problem.” “The southeast, that's a great market.” It’s not only from a demographics perspective, people move in there, but also because it's warm so there must be a lot of bugs.
When I look at pest control, for example, I look at Mother Nature as a natural barrier to entry through seasonality. When you take the northern climates, take Minnesota, Michigan, and those climates, it becomes much more difficult for the smaller, less capitalized companies to compete because of the seasonality. You have to be much better at managing your cashflow. On top of that, because you have that natural barrier entry, it's harder to compete because there are less pest issues. You've got to be better in other aspects of your business so that favors the well-capitalized and it also favors the more intelligent businessman.
You get into the warmer climates, it's like, “There's a lot of bugs, there's a ton of competition. I can go out there and compete on price.” In northern climates, you've got to be more sophisticated. The resi services space has been interesting for me over the years. I've been at this for over twenty years. I was on the tech side, so I started at Credit Suisse. I was out in Silicon Valley working for Frank’s tech group. My coverage group was large-cap tech. We did the contract manufacturers like Electron and those sorts of things. The computer OEMs, and then Software, Apple, Microsoft, Cisco, Gateway, and Dell, a lot of these companies are no longer with us.
I left that and I went to American Capital. I was on the buy side. At the time, American Capital was the largest publicly traded buyout shop in the United States that has disappeared. It's been acquired by Allied Capital. When we founded Potomac in 2003, we focused on a broad base all across resi services globally. That was HVAC or lawn care, you name it, anything that touched home. Private equity was not in this space at all. For the most part, there were a handful of private equity-backed roll-ups in the time, but it has been the last decade and acutely post-COVID where resi services have gotten more sophisticated.
Clearly, you've got buyout shops with a ton of capital, and in extremely low interest rate environments, it's the roll-up game, This is what we've been dealing with. There are things random stuff that you never think about. I've come across gutter repair and maintenance companies that started as a one-man shop and now have hundreds of employees. They have the installation revenue but they got a ton of recurring revenue because they sell these maintenance plans. It’s super capital-light and has high gross margin profiles.
Jonathan Pototschnik: We had a number that were Service Autopilot members that were in multiple states. That was an industry I never would've thought of.
Paul Giannamore: I would never have thought of it either. It's just you having your tentacles into all these various different service businesses. One of the huge distinctions for me for some of these guys was the guys that had spent a lot of time understanding how to market their business, how to develop all channel partners, how to get to the homeowner, and studying a direct response. Everyone makes fun of me because I talk a lot about postcards. Everyone's like, “That's ridiculous. You should just be doing it online.” If you're able to do postcard marketing right, if you can develop a message, and get a direct response from that, it is extremely scalable and I've seen companies do it.
Jonathan Pototschnik: From a pure expansion revenue standpoint, you've already taken the client off the market, there's now trust. Postcards are, in my opinion, an absolute no-brainer in that market. What you're saying is you can build new clients with postcards as well but if you want to step into that world and test it, use it selling back into the existing base you already have. I couldn't agree more. Mailboxes are emptying out. Paid ads are expensive. The economics are balancing out.
Paul Giannamore: You got a lot of these marketing firms, they're all into digital marketing, and that's just one media, that's one channel, but they don't spend a lot of time going multi-channel into direct mail postcards, that whole nine yards. I do think you're right, mailboxes are emptying out. There are some businesses that I don't like in particular. I'm not a huge fan of HVAC. I tend to think about things from a consolidation perspective.
If I were to get into a business, I would care about gross margin profile and scalability and so on and so forth. I'd also be thinking about, “What is my ultimate exit opportunity as I build this?” Clearly, the landscape will be different five years from now than it is today or ten years. One of the issues that I've always had with HVAC businesses is there's a low level of recurring revenue in that space and you're constantly having to resell. These installations are huge. They're complicated to route and everyone's always got an emergency.
You talked about pain earlier and there's nothing better than you're in an HVAC business in the middle of Texas in the summer and the AC goes out, that's great, and that's a shit ton of pain. You got to get that fixed or your wife's going to kill you. That's also painful for you, the operator. If I got a gutter problem, I can wait a couple of weeks, “We're booked up. We'll schedule it three weeks from now.” Your wife ain't letting you wait three weeks on the AC in a July Texas inferno. There's some second-level thinking.
Sometimes when I hear them talking about, “Let's go to Florida because of pests.” There are a lot of other things going on or let's do HVAC because of high-pain. That's high pain for you too from a routing and scheduling perspective. The more efficient on resi services that you can be with getting a customer that's sticky, paying you their recurring revenue, and being largely in control of your scheduling allows you to be extremely efficient. That's where you get the margin expansion on the gross margin line.
Jonathan Pototschnik: Based on your expertise, I'm curious, it has to do with private equity and valuations. I know nobody can predict the future but you've definitely seen the roll-up in HVAC, it's just valuations, from my perspective, just keep going up, which makes that space unattractive to acquisitions, in my opinion now simply because now you're competing with all the private equity money. If you think about it in that way, you're seeing the growth in private equity interest in pest. I'm seeing it's coming into the green industry, for sure.
If you are predicting out into the future and you're riding the trend or getting ahead of the trend and you may not be able to answer this, but where do you see private equity momentum building where it's like, “If I was betting five years out, there's going to be a lot more roll-up activity in this space.” I also predicate this, and I understand that if private equity doesn't get some pretty strong exits to strategics or whatever the case might be, the thesis goes away and maybe it dries up. Directionally, do you have any guesses on which industries might be places for expanding multiples?
Paul Giannamore: It's one of those things where, at the end of the day, sometimes I wish I could short some of these roll-ups. If you think about it from an investment perspective, the higher an asset trades today on a multiple basis, the lower the forward returns are. It's just math. I pay more for something today, my forward returns are going to be lower.
If I take the pest control industry right now, today, you have roughly 70 to 100 financial sponsors that are trying to get into this space to one degree or another. Some are toying around with a thesis and others are actively out there bidding. You have at least two dozen real bidders in the pest control space. As additional capital is attracted, multiples are bid up, and of course, these guys are bringing real management teams, investing in a lot of capabilities, rewriting routines, and doing a lot of things.
When I think about the private equity industry, if you look at what are the big value-creating levers that these guys have, at least on the residential services side, you've got route density. The arbitrage from the whole playbook is you go in and you buy a platform business and then you go on and make acquisitions and you blend down your entry multiple. The problem now they all face in the HVAC space is there's a limited amount of smaller add-on acquisition opportunities vis-a-vis a lot of the other industries.
In the lawn care space, there are tens of thousands. If you're buying a platform at 15 to 20 times EBITDA, you gotta be able to go out there and buy stuff at 6, 7, or 8 times EBITDA. If you can't do that, that's now a problem. We've seen saturation in HVAC, quite frankly. That's slowed down. Jonathan, to your point, at the end of the day, when these guys can't exit these at high multiples, that's when I think the music starts to stop.
We haven't gotten into that harvesting phase yet on the resi services side. I will tell you that there are a handful of businesses out there in the HVAC space that are Frankenstein's, that no one will touch. There are $200 million HVAC businesses out there, which is an amalgamation of 40 different businesses that makes hard exits.
To your point, you're oftentimes better buying 1 A-plus business and paying a high price for it rather than going out and buying 20 crap businesses and then you spend a lifetime trying to put them together. If you buy the A-plus business, you can get away with buying some mediocre add-on acquisitions. If you start with a bunch of crap, you get into a world of hurt and there are a lot of these Frankenstein across the industries. There are a few on pests too. Look at lawn care, there are a few of them. HVAC's got a ton.
Jonathan Pototschnik: What's your take on buying in general? If it's your capital and maybe you're not the CEO but you're running the business with the leadership team, you're the visionary of it, we'll call it that, and you're deploying your own capital. I believe I can acquire clients cheaper than I can buy them but I can go faster by buying and growing organically. Do you have any personal opinions based on everything you've seen over the years on how you would do it?
Paul Giannamore: You talked about the architecture of the software. At its core, if it's a cluster, you got the customers, that's great, but you're going to have to rebuild that from scratch, which is a time-consuming and expensive process. There are tremendous opportunities to buy businesses, which get you from point A to point B much quicker. You don't necessarily have the same issue, on a surface business, as you would on a software business.
There might be some bad habits there or some routines that need to be changed. It's great to start something from scratch, I've done it a handful of times, but it's much better to buy a business that you can build from. There are so many guys out there. If you take the search fund community, these are guys that are a couple of years out of business school, they raise a few hundred grand, they've got some backers, they go out, and they send emails to lawn care guys and pest control guys saying, “My name's Paul. I want to buy one business and grow it. I've got all these backers. This guy is Harvard and this guy's Columbia.” All this nonsense.
There are people that won't run a process, they'll sell it. We sold a business of $50 million in revenue to Rentokil a couple of years ago and those guys were search funders and they went out and they found a $5.5 million business, it was $5.5 million in revenue, and they were able to buy it at 4 or 5 times EBITDA. They bought that thing and they did add-on acquisitions and they grew it organically to $50 million and they cashed out a grand slam and sold it to Rentokil.
If you can buy a good business at five times EBITDA, you do that all day long, you've got such a margin for error in there if you're buying it so cheap. I'm a big proponent of that. Now you gotta kiss a lot of frogs. It’s an extensive process to try to figure that out but you can do it. I haven't done this since COVID, but twice a year, I'm on a judge's panel, INSEAD, which is a business school in France. They have a program there where entrepreneurship via acquisition. It's the search fund mecca, so to speak in Europe.
I have a lot of discussions with these guys that want to be searchers and they get focused on understanding the industry. They do a lot of industry research and they say, “Here are 4 or 5 verticals.” I've learned over the years that it's far more efficient to be less concerned with the industry and the vertical and find the opportunity. Now you might find it in an industry where you're like, “I don't know anything about that or I don't know if it makes sense.”
If you could find an opportunity that you can buy on the relative cheap, then you do your research and see if it makes sense as opposed to going out. The private equity firms do the exact opposite, they determine what's their thesis, what's the industry, and they go out and try to find the opportunity. You can dramatically cut that short. I tell searchers that all the time, look for the opportunity first, and then figure out what the heck you can do with it and see if you can build a thesis around it.
Jonathan Pototschnik: I appreciate it. I told Patrick that I have two challenges. One is I know what it takes to build something. Anytime you think about doing this again, it's like, “Do I want to do all that?” The second thing I think about is you take all this money off the table and you look at all the places you can deploy it. For me, I'd already been deploying it in a lot of these places because I've been doing this for a bit. It's like, “The best place to put my capital is right back into the stuff I was already doing.” Meaning, to your point, if you could buy something for five times EBITDA. There's no guarantee I outperformed the markets but my track record so far is that I do. I struggle with that. It's like, “This is the best place to deploy.”
Paul Giannamore: When we started this business back in 2003, it was me and my partner, and this was back in Philadelphia, we met a guy who was from Philly and he went and worked for a big software security company, I can't remember which one. He was in his 30s and he wanted to get outta Dodge and he's like, “I need to start my own business but starting my business is difficult. I want to buy one and I want to buy a software business.”
In 2003, this is post .com bust, he said, “Can you guys help us or can you help me do this?” We're like, “We don't know but we'll see if we can figure this out.” Back in 2003, we sent out 500 letters to software companies and we came across a point-of-sale software solution that was based in Buffalo, New York. It was a small business. Back in 2003, maybe it was doing $3 million a year in revenue. The guys that owned it were doing this software for the hospitality industry.
They called us up and said, “We've been thinking about selling the business.” I don't remember what they were doing, $700,000 a year in EBITDA. They're like, “We want at least $2 million for this business.”W We're like, “Okay.” I didn't know anything about the hospitality industry but I went to Cornell and that's where the big hospitality school is. We called some folks over there, had them take a look at it, and our clients are like, “I can buy this for a couple of times EBITDA. I don't even care what it is. I'm going to do this.” The business has been around for over twenty years.
He bought this software business and moved up to Buffalo. He's spent a couple of million bucks. He used an SBA loan, bought it from these old-timers, hired a bunch of different developers, and got focused on marketing. He scaled that thing in 24 months and I want to say his exit in 2005 or 2006 may have been $90 million that he paid $2 million for it. $700,000 in cash and it was a small business, $3 million in software but it was just so untapped what they had done with it. Those sellers had no idea what they were holding. There are a lot of opportunities to do that.
Patrick Baldwin: That's good. Does that inspire you to get back into software?
Jonathan Pototschnik: I already bounce around on this one. I'm conflicted. If I'm going to build and sell, I like the multiples of software quite a bit. I enjoy that space. If I'm going to build and hold and I might make acquisitions along the way, I like services. On the services space, one of the great gifts I was given having come from the software space is you have to know your data. You're competing against funded organizations that will spend unlimited amounts of money on CAC and you have to be more efficient because you can't play their game. You have to learn your numbers and your metrics.
The sophisticated guys running these service companies, sure, they've learned that stuff. If you look at the whole, it is mind-boggling how many people don't even know they're cogs. We're not talking about your $20 million companies but there are so many. When I think about the sophistication of the competition versus the sophistication of the competition and technology and what you make or can make in the way of profits, services are attractive.
This reminds me, Patrick, we were talking about this because I was making the argument that, yes, the story is that gross margins, and as a result, EBITDA in the software space are amazing, the best, and they are sometimes. How many of the best companies are pretty much a gross story? There's still no EBITDA behind them. Whether this be a few public and a bunch of privates, to a large degree, in all of these software companies where we're promised incredible margins, it's a story of what's coming someday out in the future.
If I'm deploying my own capital and I want to return on my capital, yes, you get that in software sometimes, but you don't get as much as you might believe you get it is my general argument. Having had experience in the service space, I know how to make nice profit margins in service. It's like, “Which is better?” There are some moving parts in services that are difficult with the recruiting employee problem that creates some challenges. Let's be honest, there are also problems in software. There is no easy road, it's all hard, and it's just which problem you want to solve.
Paul Giannamore: I guess you could argue in software is more of a winner's take-all model. One of the things when I left the CSFB tech group, we set up the business in Philadelphia. I wanted to be in New York and my business partner was like, “We need to be bigger fish in a smaller pond.” While we were doing that software deals, we had a background in tech. He was in Silicon Valley, he was a CFO of a big startup that was acquired, and I'm a tech banker.
We started in tech and shortly thereafter, I'm like, “Tech is sexy, it has attracted all the smartest guys.” We stumbled upon these boring, blue-collar, mundane businesses, and we're like, “The guys that we compete with on the advisory side are guys that used to just be technicians themselves. Now they're out advising people with zero formal experience or formal training whatsoever. This is awesome.” I do think there is something to that.
A pest control business or a lawn care business or any of these businesses are particularly difficult businesses to break, they're relatively resilient, and they grow inch by inch so you're not going to get this spectacular upside if you nail it right in software. At the end of the day, software sometimes is winner-take-all and you gotta have the capital.
When I think about securities, I think about the duration of an asset, whereas the immediacy of cashflow today versus cashflow in the future. Clearly, depending upon where you think the macroeconomic environment goes here in the future, one could argue, we were in 40 years of declining yields. That favored long-duration securities over shorter-duration securities cashflow in the future versus cashflow today.
I can see how one could make an argument that if we are now in an era of real and rising interest rates, the immediacy of cashflow would be far more important from a valuation perspective than long duration cashflow out in the future. What we're seeing now, at least in resi and commercial services, is there is consolidation there. We've seen yields go up but we're also seeing a rotation into the immediacy of cashflow at the expense of longer duration type securities or technology.
Jonathan Pototschnik: Would that be more towards businesses with fewer assets and less investment required? Would those be the ones that are more in favor than in a higher interest rate environment?
Paul Giannamore: Typically, yes. You can almost make it simple to almost like a red line test, meaning cashflow today versus cashflow tomorrow. When you talk about software, you're talking about the growth rate on the top line. You’re looking at revenue. At some point, you're making the assumption as revenue grows, cashflow will appear at some point in the future.
If you take a look at a hundred years of financial history, when you're in an environment of yields from a valuation perspective of where we see the rotation of capital, it favors companies that have immediate cashflow, cashflow today versus cashflow on the future. It also implicitly means growth rates are not nearly as important as they are in lower interest rate environments because of the pricing mechanism and time value of money. I always tell our readers that in 2021, acquirers cared far less about cashflow today.
In 2021, we had a lot of discussions, even past and resi services. People were focused on growth rates, which was important. How quickly is this business growing? Now, everyone's looking at what is your EBITDA margin. Now growth rate is important and they want to see solid organic growth rates but it's that immediacy of cashflow. That will probably continue for a while, unless until the US has to do yield curve control. Who the hell knows what happens? Buy gold and bury it in the basement and hide, I don't know.
Jonathan Pototschnik: In this particular conversation, I struggle with which side of the line to fall on here because it feels that we are going to continue to be in a higher interest rate environment. At the same time, I can't fathom how we get away from a world where politicians continue to deliver services to get elected and they, in some way, push these rates back down. I don't know if there could be an argument, “They can't control it to that degree,” or, “They can't apply that much pressure to have an impact on that.” That's the little caveat that I can't quite get my head around, the politicians have a never-ending need to deliver more and more stuff. How do we pay for this stuff? Will that bring rates down?
Paul Giannamore: 100% exactly what you said is going to happen. These guys are going to have to print money in order to keep the wheels on this thing. It translates into higher nominal interest rates. From a real rate perspective, the rate of inflation increases, and nominal rates go up, but we're still going to be treading water at 0 to 1% in real terms. There's probably going to come a point where we get back into negative real rates.
The only way out of this is liquidating the debt, they're going to have to liquidate it. How do they do that? They just print money. That's where we're going to end up. In the US right now, with the balance of payment problems that we have, if you look at how sovereign debt is trading, we are starting to exhibit the same characteristics of an emerging market economy. It's something that I think will creep up slowly and hit us all at once.
Jonathan Pototschnik: Can you give me a little bit of an example?
Paul Giannamore: When you start to think about emerging market economies versus the United States, when you look at long-duration bonds, you look at the market, you've got T bills on one end of the spectrum, and then you got 30-year treasuries on the other end of the spectrum. The US has always acted as a relative safe haven. The Swiss franc, Japanese yen, and US sovereigns have always been safe-haven flights to quality. You can begin to see when you had, for example, the recent banking crisis, even during the US great financial crisis in 2008 and 2009, even though the crisis emanated from the United States, the safe haven bid was in the US. In 2023, with the banking crisis, we had the dollar rolling over. We had the 30 yields cracking.
Jonathan Pototschnik: That's what you mean by the exhibiting characteristics.
Paul Giannamore: Exactly. The safe haven bids were no longer here in the US. The safe haven bids were in the Swiss or even the Japanese yen. The JGB, the Bank of Japan now is in the process of controlling yields. I don't know if you pay much attention to this but the Japanese central bank is keeping the 10-year yield between 0 and 25 basis points and they're buying just a shit ton out these JGBs or Japanese sovereign bonds. This is ultimately where the US is going in a variety of historical indications of the bid to quality in the states that are starting to falter here this year.
Jonathan Pototschnik: I was under the impression that during Covid we became the safe haven again. Are we regressing to the mean now on the other side of this? Compare us back to ‘19, where are we at?
Paul Giannamore: That's an interesting question. Everyone talks about the US dollar as being the reserve currency. everyone's like, “The BRICS,” and everyone wants to create a new system now where the US dollar is no longer the reserve currency. There's almost this bifurcation in the market where people believe that the US dollar is going to disappear as a reserve currency or there's no alternative so it's got to remain.
If it remains, the dollar has to remain strong. I do think that we're now moving into an environment where we're going to see a weak dollar. I don't know if it's regressing to the mean, necessarily. It might even roll past that. I do think that we're beginning to enter that environment. When you think about it from a capital flows perspective, we're effectively at the end of the Fed hiking cycle. Maybe they're going to raise it another 25 or 50 basis points but they're about done. There's nothing in the market that makes anyone want to catch the US bid.
Jonathan Pototschnik: By bid, meaning they feel any urgency to buy here.
Paul Giannamore: Yes. Patrick knows this. All throughout COVID and all the way through the entire hiking cycle, I had been super long dollars. That was one of my biggest asset allocations in 2021 and ‘22. I don't own any dollars now. I do own dollars like real dollars but I'm not buying dollar futures for example anymore. Everything from dollars now has been allocated into gold quite frankly. It's complicated when you exit a business and you're probably sitting on a lot more cash than you used to sit on and you're not making as much money.
You don't have that business kicking off cashflow so you get this pile of cash and you got to figure out what to do with it. You're probably like, “Now I'm going to an inflationary environment.” That's slowly evaporating and valuations continue to be extremely elevated so forward returns are low. What do you do with this stuff? It's a complicated investment environment right now as you well know.
Jonathan Pototschnik: That's exactly what I've experienced. I'm the guy that started investing when I was 20 and I cost averaging. I traded in and out of stocks back in the day in my 20s. At some point, I realized I'm not doing any better than just averaging in that old story. I've been a diligent saver and investor in a number of different buckets. Two mistakes and one of them was the right advice but it turned out to be the wrong advice for a situation.
Several individuals that have made multi-hundred million dollar exits said, “Wait a year before you deploy any significant capital.” I shouldn't have waited. I was too conservative with the bulk of it because then we went into our best buying opportunity in the 2020 range. My single biggest mistake, if I don't know better, I put about $10 million. One day I just bought and I bought near the lows and it was before the Fed had started talking.
I did not understand the impact of capital from the government coming into the markets. I don't even think we knew exactly what was going to happen yet at that time. I thought this is going to be a dead cat bounce and I sold all that stuff and then I just watched it run. I screwed up. I don't know how I got off in this tangent but it's one of those things. I almost think about that more than exiting the business too soon because it's like, “What a stupid mistake?” After all these years, I knew better.
Paul Giannamore: This stuff is easy in retrospect to go back and look at and it's difficult to pull the trigger in real-time so it's normal.
Jonathan Pototschnik: I felt like a lot of my beliefs on how I would deploy capital and what I would do, I generally think I was thinking about things correctly but we went through an environment we've never been through and it blew up all the things I had programmed myself to believe over the years of reading books and thinking about 50 years of data. It's the whole bonds versus equities, you're moving in the same direction. If you try to be prudent and you make bets based on data, you're just doing the best you can. A lot of that stuff was wrong. At that exact moment, I took the money off the table. It's all worked out, it's all fine, but it's like, “Bummer, I missed a bunch of opportunities.”
Paul Giannamore: This is what makes me concerned. When I think about the private equity industry or any of these alternative assets where the majority of these people have grown up in one era. At least half of every private equity professional, his career has been basically post-financial crisis. They've only seen ever-decreasing yields. They've seen ever-increasing equities. They've seen one great exit after the next.
The guys that were doing this back in the late ‘70s and early ‘80s are not around anymore. This is the environment now where passive investing, which I view most private equity firms as relatively passive investors. It's going to get much more difficult here in the future. We're just starting to see the beginning of this where actual intelligence and doing the hard work and making the right investment decisions will pay off. Passively buying an index or passively going in, rolling something up just because it's worked forever, I don't think this stuff is going to work long-term.
Jonathan Pototschnik: Private equity is especially interesting. A lot of people tout their incredible returns. What they're doing is they're being told what their rate of return has been and then they roll to fund 2 and roll to fund 3. They've oftentimes not extracted their money out of these funds. I don't know what the real return is going to be. There are some phenomenal private equity deals. Obviously, it's a mix. That's one thing I find interesting. There are many individuals that still love private equity but it's fully based on stated returns and not actual money extracted from the funds. I find that interesting.
Paul Giannamore: Trillions of dollars of this haven't been marked to market yet.
Jonathan Pototschnik: That was my next thing. I sit in the room and I can be negative on the stock market too but we can be negative on the stock market. We can be negative on anything that we can see our people worth $100 million dollars. We can be negative seeing the variance, and volatility, but we just aren't worried about our private equity stuff. I've got two private equity guys in my group. Isn't the mark to market on your stuff based on what's going on in the public markets?
We get to tell ourselves this feel-good story about, “My private equity investment is still worth $20 million.” Is it? It's only because you're not getting it marked to market all the time. I find psychology, what I'll call a more sophisticated investor level, to be fascinating. What I've come to conclude is I'm not putting anybody down. I've got all my own loss. I've got a guy that made the bulk of all his money in real estate. He's good at real estate.
I've got a guy that made the bulk of all his money in private equity. He's good at running the operations of private equity. I got a guy in oil and gas. I can name them. Once they get outside of their area of expertise, they're not as impressive and I think of that as a lesson to myself. Going back to the idea of where do you deploy capital? Do you buy service companies? Do I buy software things?
That's where my expertise is. I keep witnessing these things that make me think that a lot of money is made in the thing you're an expert on. You might feel like you're making tons of money in passive investments or telling yourself a story that you are but the reality is it only matters what you invest in and what you extracted and what are those real numbers. I suspect they're not as good as most people think they are.
Paul Giannamore: I haven't seen that in my own life. There's a very narrow spectrum of what I'm good at and I'm shitty at everything else. It's taken me a long time to realize that and recognize and put it to work and make sure that I have the right people doing the right things. As you said, the real estate investor, he's good at making money in real estate. He's probably not a guy that I would get into subprime bonds with.
I deal with this stuff all the time. Success in running and building a business doesn't mean you're going to be successful in running a formal sell-side process. It's a different area. It's one of those things where everyone that sells a business and has a huge exit, their stress level is different from when they were running a stressful business because at least they felt like they were in control of their own universe. When you got a pile of cash and you don't deploy cash on a day-to-day basis and that's not your experience, then you trust every single financial advisor, which you should because most of these guys are jackasses. What do you do with it?
You were talking about you put money in the market and then you sold it. You performed correctly because preservation capital and risk mitigation is the most important thing for you. Unfortunately, I have been on the other side of trades that have gone wrong to huge, massive amounts of money, and so I've learned the hard way. Preservation of capital, of course, is your number one job now. It's not to get those massive returns, it's to beat inflation and continue to compound it.
Jonathan Pototschnik: That’s how I think about it. You won the game, incremental probably doesn’t matter. In my situation, we're not going to spend them. It's all about bragging rights after that and it doesn't even matter. Preservation of capital matters.
Paul Giannamore: That's the name of the game. In my YPO group, I've got a lot of guys that are always swinging from the fences and I'm like, “I don't know that I would be as aggressive if I were you.” Any incremental dollars are not changing your lifestyle or your family's lifestyle whatsoever.
Jonathan Pototschnik: My theory on that one is it's the old thing, “I built this one successful thing. I can build twenty successful things.” I don't know. You don't see that very often. Most people build one good thing.
Paul Giannamore: People discount the impact of luck on things in life. Sure, you got to be smart and you got to work hard and you got to do all those sorts of things, but we all know hardworking smart people that were unlucky. What's the old saying, “I'd rather be lucky than smart.” I've been largely lucky. I don't think I've been particularly smart.
Jonathan Pototschnik: It's all got to come together. Yeah. Everything has to come together. A little bit of why I was asking some of the questions I ask is I think about trends. My dad, we used to race bicycles for the US racing team. He lived in California. I'm Patrick I might have told you this. He knew he was becoming an artist and one of his racing teammates was moving to Wiley, Texas, the middle of nowhere so he could live in the country. My dad's like, “That's where I want to live as an artist.”
Little did he know, he was going to move to one of the fastest-growing places in the United States that I benefited from. If he had moved back to Wichita, Kansas, where he grew up, we probably wouldn't be talking. To me, that’s a version of luck. I think about that stuff all the time. How can you put yourself in the direction of luck? A lot of times it's trends. What do you think about in terms of private equity? Are they going to get good exits or will they stay in this game and keep acquiring? Are they going to move to their next space? If you're going to play the game, you might as well try to get lucky. There's an element of at least trying to take as good a bet as you possibly can.
Paul Giannamore: When I was in London, I can't remember the name of the speaker, but I went to this event and he was talking about the same thing that you were talking about, Wichita to Kansas versus Dallas. He didn't use those two cities but you're talking about the impact. Parents are so concerned about the schools, this, that, or the other.
A major impact on the potential of your children's life is where they grow up and the actual people in the immediate neighborhood who they're surrounded by. In one city, if you're on the shitty side of town, you're with a bunch of people who have the victim mentality and all this sort of stuff. One city versus another city and a country versus another country. For me, it's been interesting.
When I spent a lot of time in North Africa and the Middle East, we tend to look at countries from an absolute wealth level but the happiness of society is largely based upon progress. Is the country going in the right direction? Are we getting wealthier? Are my neighbors getting wealthier? Is our quality of life improving? In places that I've gone to over the last 25 or 30 years, you're able to see the quality of life improvement and so on and so forth.
I'm in the US 30 days or less per year, every year for almost 20 years. In a lot of ways, I'm almost a foreigner. I come in and get to see the US more of a snapshot as opposed to you guys who are in the fish tank. To me, it seems like things have changed dramatically over the last couple of decades or so obviously from a political perspective as well as this generation is not necessarily going to be better off than their parents, which is unlike a lot of other places in the world.
Jonathan Pototschnik: Your point resonates with me. My wife has historically not been too gung-ho on Asia. She's pretty good at language and so she's always found those languages to be brutally complicated. We both agree that Vietnam is one of the favorite places we’ve ever been. That feels like a place where everybody's life is getting better and has been getting better for multiple decades now. What their life is today versus back in 1991 is not even similar. There's this excitement, this energy, this optimism, and this promise of possibility. We've tried to figure out what is it we like so much about Vietnam, we think that's a lot of it. That optimism and improvement growth is what gave that place energy and made it quite interesting to us.
Paul Giannamore: You can see it when you go to places like Southeast Asia and you go to the Middle East because ultimately what ends up happening, and this is my belief, is that if you can see life improve real-time, it allows people to have hope and aspirations and they plan for a future. They're starting to plan for a future, they change their current behaviors because now there is a future.
Jonathan Pototschnik: It’s probably related to population growth as well, having kids.
Paul Giannamore: No doubt about it. As you're changing present behaviors because your future is largely more bright, you make better decisions, and you invest in society and it continues to advance. When people start to lose hope, they're like, “What the hell? Why do I need to do that?” In that way, the US is not looking like an emerging market economy, it's looking like an old, tired democracy, it's unfortunate.
Jonathan Pototschnik: Stuff's complicated. You talk about the US specifically, it's so hard to make predictions because there are so many moving parts. I do buy into that general belief that there's an argument that the more we talk about a problem, the more somehow we tend to navigate around them. I'm not saying we're going to navigate around all of our problems but there's been a lot of things predicted over time where it was all going to go sideways and we've somehow muddled our way through in spite of the insanity. It's hard to cast a bet. We're still the best house in the crappy neighborhood argument. I know that there's a lot of holes in that argument but it's complicated.
Paul Giannamore: Things take a lot more time to play out. Our natural life is 70, 80 years, or whatever. We're talking about stuff that takes centuries to play out. When we think about it, we think, “X happened si in the next ten years, Y should happen.” Maybe Y will take another 90 years, which is a short time in the scheme of history but for our finite lives. It is hard to obviously to make those predictions. I spent a lot of time in conservative places.
I'll be in Riyadh, Saudi Arabia, or Doha, and then I go to the West Coast of the United States and I hear 10-year-olds fighting about whether or not they're boys or girls type of thing. It's insanity to me. I saw young girls harassing a 10-year-old boy because he didn't want to put on nail polish. You got all this gender stuff that goes on. For me, it's always surprising because I go to the United States and I'm like, “Why are people even entertaining these sorts of discussions?”
I live in Puerto Rico and I constantly every day hear about colonialization and all of this sort of jazz. The people in Puerto Rico are so oppressed. I've been to Syria so I say, “Why don't you go to a Syrian refugee camp? Why don't you go out into the world and see what real oppression looks like? Spend a couple of weeks in Sudan. It’s a great opportunity to juxtapose life here on my tropical island who are angry because they’re not getting enough in their unemployment checks or whatever they’re concerned about here. It’s ridiculous.”
A lot of Americans would benefit by spending time in Western-European countries. I'm not talking about just going to France, go out and understand how poor the average European is. Understand how the level of confiscatory taxes these folks pay. Understand how unbelievably difficult it is for any youngster under the age of 35 to get a proper job there due to just nasty structural inefficiencies in the labor markets.
I challenged them to go to Italy or any Western European country and try to start a business. It is spectacularly bad compared to what Americans face. Of course, youngsters today, “We want the Swedish model,” or, “Look at the French.” Your average French high school student is going to Starbucks with her friends and sharing a cup of coffee because they can't afford to buy one on their own. We don't hear about that though. We hear about how great free education and free healthcare are.
Jonathan Pototschnik: It's interesting.
Paul Giannamore: I should start giving tours to the real Europe.
Jonathan Pototschnik: That's right.
Paul Giannamore: Like the real Peterman tour, Patrick.
Jonathan Pototschnik: I enjoyed it. It was engaging for me to have the conversation so I appreciate it.
Patrick Baldwin: When was the last time that someone brought a pen and started taking notes and asking questions?
Paul Giannamore: No one has. Johnathan, I appreciate you getting on, it was fantastic. You're a super sharp guy. I enjoyed talking with you and hopefully, we'll get an opportunity to meet.
Jonathan Pototschnik: I'd love to.
Paul Giannamore: Most likely we'll get an opportunity to meet perhaps overseas because I do a lot of traveling. Vietnam is on my target here.
Jonathan Pototschnik: We love it.
Paul Giannamore: I've got an office in the Philippines. I'm there every other month. I spent a lot of time going to places like Malaysia. I love Vietnamese food.
Jonathan Pototschnik: Over Thai food, it was a standout.
Patrick Baldwin: Jonathan, great to see you. Definitely enjoyed our chat as you can tell why we spent four hours hanging out together, it seems like it carried over for a couple of hours here.
Jonathan Pototschnik: It was great. I enjoyed it. Paul, a nice chat with you. It's a good time.
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Paul Giannamore: You shortchanged us on the front end. What do you have to say on the back?
Patrick Baldwin: I'm glad you and Jonathan have put up with me for all these years, so thank you.
Paul Giannamore: Jonathan's a good dude, man. I enjoyed the discussion with him. He's wicked smart and has got a lot going on, so I appreciate you getting him on into The Boardroom.
Patrick Baldwin: I'm excited and anxious to see what's next for him as he is been on sabbatical.
Paul Giannamore: Me too.
Patrick Baldwin: He's got some irons in the fire he just can't tell us because then his wife will find out.
Paul Giannamore: I sensed that as I was speaking to him.
Patrick Baldwin: I have a question though because this was new to me. One thing he talked about is it pays for itself to have an advisor, I couldn't say that better than he did. Of course, I can't speak, so that goes without saying.
Paul Giannamore: Clearly, but if you were to speak.
Patrick Baldwin: He talked about non-exclusivity going into the process. He has an advisor, three going in where they went through DD, which sounds extra painful for what it's worth. Have you done a process like that or is there a reason to?
Paul Giannamore: Yeah, I've done a handful of them like that. What he was specifically saying is he had three buyers going through confirmatory diligence simultaneously. He was not exclusive with any of them. Had we taken that discussion a little bit further, we would have realized that there was a short period of exclusivity, it could have been a week, two weeks, or a month. It was probably a small period of exclusivity.
Effectively, that happens in competitive auction processes. When we ran the Nomor sell-side deal, we sold Nomor to ServiceMaster, which was a $200 million transaction in Europe. That was a controlled auction and that's how you run a controlled auction meaning as you start the process, you might have 20 bidders, 50, or 100, you've got a lot. Through successive dialogue in meetings and bidding rounds, you begin to whittle down the playing field so people stop and they drop out as the price continues to increase.
You might find yourself with three bidders. Interestingly enough, on Nomor, we found ourselves with three final bidders that began to do confirmatory diligence. That means that they are in the data room, they're hiring financial advisors and transaction services folks, and they're doing diligence on the company simultaneously with other buyers. While you're going through that confirmatory diligence, the lawyers are passing a purchase agreement back and forth and marking that up.
You get to a stage where you get to the end of the final round and after everyone has done confirmatory diligence, you say, “You've done the DD, now you're going to make a final offer.” That final offer could be binding, it could go right into the purchase agreement, or it could be another iterative bid prior to getting into the purchase agreement. In the Nomor case, we've talked about this on The Buzz before, we used a Dutch auction.
We did DD with multiple parties, none of which had exclusivity, meaning they weren't the exclusive buyer at this point in time. They all had to compete against each other and spend hundreds of thousands of dollars in DD. At the very end, I decided the best course of action was to do a Dutch auction, which was effectively to say, “If I need to get $200 million for this business, I'm going to choose a purchase price that's higher than that.”
I'm going to say you will be able to get into exclusivity, which means I have to tell the other buyers to pound sand if you meet this bid and you've got 24 hours to accept or reject it. If you reject it, it goes to the next buyer and it goes down. It starts at $220 million. Fat Pat, you're like, “No, I'm not going to do $220 million, it's too much.” The next day, it goes to another buyer, “Buyer B, you've got 24 hours. The bid is $215 million, accept or reject.” They reject it.
I'm making numbers up as I go but now it goes from $215 million to $210 million. Now it goes back to the original buyer, it might be $209 million or $208 million. As you get closer and closer to the successive numbers, there's less delta or difference between the numbers. At some point, somebody will hit that bid and then they win exclusivity. That's a Dutch auction thrown in at the last minute of a traditional standard controlled auction.
You're bidding the price up and then you take the price way up and then you have a reverse auction. That's how you can be pretty comfortable that by the time you get into exclusivity, you've gotten full-price discovery and you've extracted all dollars out of the market. You've also got a counterparty that's relatively secure because now they've already gone through DD so they're not going to find anything in DD that's going to surprise them because they've done that. That is what Jonathan was talking about. They did DD with three buyers simultaneously and we didn't get into the final mechanisms by which his bankers executed that process.
Patrick Baldwin: Are you curious?
Paul Giannamore: Not particularly. I have a feeling it was probably a standard controlled auction. Dutch auctions are not always great things to do. There are reasons why you would do it and there are reasons why you wouldn't. Dutch auctions are good at doing 1 of 2 things, extracting a huge number from a way out of left field buyer, or when the purchase price is extremely close, putting maximum pressure on somebody to do something they otherwise wouldn't do.
If a purchase price is at $200 million, it's probably hard in the control auction to get somebody to go to maybe $201 million or $202 million. They might be like, “I'm not doing it. If I'm not good enough at $200 million, I'm certainly not good enough at $202 million.” What the Dutch auction does is it puts them in a position to say, “Do I want to lose a $200 million deal for 1% of the purchase price?” No one wants to do that, but they don't have an option. They'd like to be able to say, “If you'd like me and you want to do a deal with me, why do you need an extra $1 million or $2 million that's inconsequential to you, the seller.”
When the process rules say that they have to do that, otherwise they won't be in the process and you treat everyone the same. It's like, “Sorry, buyer, everyone's got to live by these rules. It's nothing personal against you.” It allows you to extract that additional money at the very end. Likewise, it also can be beneficial if you believe that there is one party that's going to be absurd and you can run a fractured Dutch auction whereby you might have 3 bidders and there are 4 bidders.
Fat Pat, you got $225 million but everyone else maybe has $205 million or $200 million.” I would go to you third. I'd wait a couple of days and then come to you at $225 million and you would think everyone else already saw a $235 million or $230 million bid and you might hit that $225 million bid even though everyone else is down at $200 million. It gives you the ability if you think there's kind of an outsider, somebody that's going to come outside of that tight closing range.
In the Nomor transaction, I didn't suspect I was going to get an outsider. What I was trying to do is extract those final little digits. I was under no impression that somebody was going to be at $225 million. As a matter of fact, I was almost certain in my mind, it was how do you get that final incremental couple of million bucks? You do that, of course, it makes the sellers happy because they say, “Not only did our banker kill it and got us a sick price at the very end, he nibbled out every single nickel he could get out of this thing.” It was a great closing dinner.
Patrick Baldwin: I bet it was. It's fascinating too. I love hearing about it. Going back to our friend JP here, Mr. Pototschnik, what do you think?
Paul Giannamore: I'd heard of Service Autopilot but I never spend much time myself noodling on the software that runs pest and lawn care and all these different industries. That’s not my schtick. I didn't know much about the software but he apparently built a fabulous business. What did you think of the software itself? You used it.
Patrick Baldwin: We liked it. Probably the reason we ended up leaving it was because we chose to get into Sentricon. I imagine we'd still be on Service Autopilot if it wasn't for that. Back then, you were on ServSuite, Servicepro, or PestPac, those are your two options. That was enough to force us to make the switch because we wanted to get into baiting. Other than that, great people, and great software. Listening back to it, what are people not asking about switching software? How quickly he answered about security and redundancy.
Paul Giannamore: I didn't think about that at all.
Patrick Baldwin: I don't even know how to measure it. You could run numbers by me, I don't know. It sounds secure and redundant. If someone like that knows what they're looking at or knows what to ask, it makes a lot of sense.
Paul Giannamore: It almost made me want to ask him the stuff we're using. How secure is it really? They always talk about how secure it is and you have these conversations but if you don't know anything, you get an idiot business broker telling you, “This is a great deal.” If you don't know, you say, “I'll do that.” You find out later, “I left $10 million on the table.” It's the same thing. I don't know how to judge.
Patrick Baldwin: Crazy the bigger it got, the bigger that target is and the more time and resources they had to spend towards keeping it secure.
Paul Giannamore: Patrick, it was a great discussion. I appreciate you getting Jonathan on.
Patrick Baldwin: For sure. Great getting Jonathan on here. One more thing, Paul, before I let you go, when this goes out, we're doing that event for FRAXN with Potomac talking about valuations and net worth. Excited to have you on there.
Paul Giannamore: I'm not excited to be there, but I will be.
Patrick Baldwin: Smile and pretend you like it.
Paul Giannamore: I like it. I'll do it.
Patrick Baldwin: See you, Peej.
Paul Giannamore: See you, Patrick.
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Dylan Seals: Thank you so much as always for supporting us at The Boardroom Buzz. We know your time is valuable and the fact that you spend 45 minutes or an hour with us means the world. All the media that we put out from Potomac is meant to honor and celebrate you, the service industry owner. As Paul would say, “Yee who toil in the pest control vineyards.”
As part of giving back, we have this podcast, but more than that, Paul and I have been working our tails off over at POTOMAC TV. We've spent a tremendous amount of time, energy, and resources to build out that platform to bring you market updates, to bring you visual breakdowns of the merger acquisition process, and to tell stories and present information in ways that, frankly, it's not possible for us to do on The Boardroom Buzz.
Adding the visual element takes it to the next level. I want to invite you to go to YouTube and find us, it's POTOMAC TV. Potomac.tv will get you there. Go there and subscribe. Check out some videos and leave some comments. Let us know what you like and let us know what you don't like. Let us know what you want to see more of and we'll see you over there.
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