46) Lower Middle Market

Behind-the-scenes building Vambrace AI, a company on a mission to figure out its mission. Please pardon the stream-of-consciousness style. Subscribe to follow along or visit the site here:

(typos are to make sure you’re paying attention)

Introductory Remarks

Dear Vambracers —

In last week’s post, Market Demand, I explored the general concept of product-market fit. The main points, I think, are that: (1) it’s critical to let market forces dictate the direction in which my offering moves; and (2) it is pretty obvious when there isn’t market demand for what I’m building, even if it’s painful and difficult for me to accept that. Today, I wanted to sketch out the latest market that seems to have some real demand for what I’m offering.

Lower Middle Market

Background

When I first embarked on this journey, I wanted to serve family-owned physical services businesses and sort of help “protect” them from the looming threat of PE-backed platforms. As my GTM motion progressed, I realized that most family-owned companies aren’t really interested in investing in new digital transformation initiatives and technical overhauls. For the most part, they’ve built a thriving and reliable business over the course of decades, and they’re (rightfully) proud of what they’ve accomplished. But many of them just aren’t motivated and/or incentivized to start deviating from their tried and true approach.

When I mention my “GTM motion,” what that really means in practice is a fairly significant set of Instantly campaigns that went to ~1,000 smaller family-owned-type businesses across physical services. For the most part, these companies are between $5M-$50M in revenue, with anywhere from maybe 10-100 employees. I did a 4-week campaign with 4 emails in the sequences, and received very little interest; like so little interest that I felt I could conclude that there was actually very little interest.

The Soft Pivot

Then, late last month, I had a very promising meeting with an emerging PE firm that was really interested in what I could offer and how it could help some of their portfolio companies, and we literally are looking at a sub-month first-meeting-to-close stat, which is huge. (The deal hasn’t officially closed yet, so I don’t want to get ahead of myself, but I’m optimistic.) This experience compelled me to reflect on my approach. I wasn’t really having much success selling to owner-operators of these businesses, I think because they’re so cost conscious and generally suspicious of a cold salesman like me.

But, following my experience with the emerging PE firm above, I realized that there is actually a massive opportunity to sell directly to emerging and “smaller” PE firms, maybe with $50-$500M AUM or something like that, where they lack internal digital transformation capabilities and don’t have the capital (or the interest) in spending money on super expensive consulting firms, but they still understand that AI and technology are key operating levers to help improve the performance of their portfolio companies.

There are all sorts of pretty obvious reasons why the PE owners of lower middle market companies are actually my perfect ICP, as opposed to the independent owner-operators themselves, and you might wonder why it took me so long to arrive at this realization. The truth is multifold.

• I was scared. PE people are generally understood to be intense. I have many PE friends and most of them are intense (in the best possible way). I think I was just downright afraid to sell to PE folks because the bar might be higher there, and there’d likely be more eyes on my work or whatever. Really, the fear was honestly probably rooted in some deep insecurities that I’m sure many people feel. I also was just starting out on my journey, and so I had a good bit of imposter syndrome and I wasn’t sure what I really could deliver on.

• I now have more confidence. But now with two production systems under my belt, I feel more confident and capable, and believe that I now know enough to figure things out. I also enjoy the puzzles that these technical transformation represent, and so I’ve gone back to my roots in a lot of ways in terms of getting a big dataset and figuring out how to transform it to achieve greater understanding and arrive at some output—which was pretty much my entire college experience.

• I was dogmatic about “defending” family-owned businesses against private equity. I was sort of raised in the world of family-owned business, and I have several relatives who have started their own companies and sold to PE firms. Most recently my grandfather’s civil engineering firm was sold to PE, and so I understand how much these companies can mean to the families that run them—and I identified with that. So when I started out, I was really trying to appear righteous or fight some holy war to help families compete with PE. But…

• PE firms, even smaller ones, have money—and I need money. The economic realities of starting my own company kicked in. I want to get this thing off the ground and start growing. I’d like to work on significant and meaningful transformation projects with willing and motivated partners. To do that, I first have to find those partners. Emerging PE firms seem like they would be great partners—and, at the end of the day, they’re just people too—and we’re all interested in improving companies and making money, and I don’t think there’s anything wrong with that.

• PE firms are going to invest, whether or not I’m involved. The whole PE playbook revolves around driving operational efficiencies at the companies they acquire, so that they can drive EBITDA margin expansion and nominal EBITDA growth to get a higher EBITDA multiple on a much higher EBITDA value upon exit. They also typically use debt capital to lever equity returns, so operational improvements are sort of fundamentally necessary. I help them accomplish these goals, and our interests are aligned. I want to help expand earnings so I justify my cost and so they continue working with me. They want to expand earnings to make more money upon exit.

• Opportunities in lower middle market. Lower middle market companies generally don’t have sophisticated digital infrastructure, and that’s typically not a priority for these companies. So there are a ton of opportunities to help build processes and systems that improve virtually all aspects of back-office operations, customer experience, management reporting, etc. They also generally are sitting on decades of data that can be energized and activated to help drive improvements in pricing, quoting.. really anything.

  • Sub-point here: my entire career has focused on smaller companies. When I did boutique investment banking we focused on companies under ~$200M in enterprise value, and so I’m familiar with this stage.

• I want to eventually buy a business. I also realized that I eventually (~3-5 years) want to buy my own lower middle market company, and grow it, and so this playbook is something I want to learn and be close to. My current thinking is that I’d love to buy an ice cream company of some sort, but we’ll see what I’m actually interested in and where the world is when the time comes for me to get #acquisitive.

So, for all of these reasons, targeting lower middle market emerging PE firms is my new focus, and it feels sort of like a no-brainer. In the initial conversations I’ve had with a few folks in my network, there seems to be interest and willingness to advance conversations and explore real partnerships here.

That brings me back to, maybe, the main point of this post which is: it’s pretty clear when you start feeling real demand for what you’re doing. I’m reminded of two Mike Tomlin quotes: (1) “There’s nothing mystical about it” and (2) “We make the simple complex.”

In this case, I dressed up and intellectualized and ruminated and assessed and analyzed and argued for why it made sense for me to serve a certain type of customer—when it was really fairly obvious early on that they weren’t optimal clients. I think I knew this deep down, but I let fear and uncertainty and doubt cloud my judgment, or otherwise numb my ability to listen to my gut.

It took me so long to see what I knew from the start. But now I’m feeling real momentum with exciting partners to build real, feasible solutions for real, interesting, and exciting companies—and that’s a great feeling. Much much more work to do, though, and we’ll keep pushing from here and see where things go.

Looking Forward

Quick spinoff here, it is truly impossible to understand how challenging entrepreneurship is until you’re actually in it. Because it’s not necessarily challenging in the ways that you’d expect, and the challenges are much more pervasive and fundamental than you might expect.

What I’m trying to do colors the periphery of my existence, like I’m inextricably linked to this entrepreneurial pursuit, and so the general struggles associated with the human condition are also the general struggles of entrepreneurship. And there really isn’t any relief.

But this is also what I signed up for, and really I wouldn’t have it any other way. It’s just weird to actually experience something that I’ve studied and discussed for pretty much my entire career.

Okay, have a great week!

Sincerely,

Luke