Josh Koplewicz – Flexible Capital and Creative Structures at Thayer Street (EP.451)
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Hello, I'm Ted Seides, and this is Capital Allocators.

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My guest on today's Sponsored Insight is Josh Kopowitz, managing partner of Thayer Street Partners, a boutique private equity firm he founded in 2012 that provides flexible growth capital to lower middle market companies in financial and business services. Our conversation traces Josh's journey from his early fascination with business and real estate to building Thayer Street into an institutional platform.

We discuss the lessons he learned at Goldman Sachs and his transition from scrappy dealmaker to fund manager. We cover Thayer Street's thematic sourcing, deal structuring, and portfolio construction, the evolving landscape for non-bank growth capital, challenges of scaling a boutique firm, and Josh's vision for Thayer Street's future.

Before we get to the interview, a quick announcement. We've set new dates for our Capital Allocators University for investor relations and business development professionals. Those dates are December 3rd and 4th in New York City. Later in the year is just a better time of year for this gathering. It's post-AGM season, travel starts to wind down. It's right before the holiday crunch time. And it's a great time for capital raisers to reflect on their previous year and plan for the year ahead.

December 3rd and 4th in New York City. CAU for IRBD is a closed door gathering for capital raisers to connect with peers, learn from allocators and other experts, and really share in best practices with each other. You can learn more at capitalallocators.com slash university. Thanks so much for spreading the word about Capital Allocators University for investor relations and business development professionals.

Please enjoy my conversation with Josh Kopowitz. Josh, thanks so much for joining me. Great to be here. Why don't you take me back to your earliest interest in business or finance? Probably informally, I became interested in it, I'd say, in middle school and high school.

No one in my family was in finance. I grew up in New York City, surrounded by lots of people in finance or real estate. A lot of those things didn't make sense to me at the time. But I was one of those kids that was always interested in following the stock market and then also interested in investing.

How neighborhoods were changing and developers were shaping them and growing up in New York City in the 90s and part of the 80s got to see development of neighborhoods evolving and people around me were involved in that and benefiting from that development.

And then when I got into college, I went to Brown, generally a pretty liberal arts education. I was a history major. And honestly, a lot of my time at school was spent working on a commercial radio station as a DJ. So a lot of my time was involved in the music business, which is definitely not analogous to the types of things I invest in today. But...

In the classroom, there are a few experiences I had with independent studies or classes with adjunct professors who were entrepreneurs or real estate developers or had experience doing lower mid-market private equity. It wasn't called that at the time. The process of learning about that evolution of a company or evolution of a development project really intrigued me. I didn't totally understand how to connect

working on those things into a linear career path. But it was something definitely of interest. And I was fortunate enough to have someone that was leading recruiting at Goldman Sachs, former Brown alum, be in a group that was doing creative lower mid-market and mid-market on balance sheet investing on behalf of the firm.

Managed to get a summer internship in that seat. It was called the Special Situations Group. And then was able to turn that into a full-time position and it was off to the races from there. In your time at Goldman, when do you remember starting to connect the dots between the interest in real estate and small businesses and the financing around it? I don't know if there was one aha moment. When I joined, I was an analyst and

our group was doing a little bit of everything. So anything that was too small for client-raised third-party funds got shuttled to our group where folks were trying to make money in interesting ways. Because there were smaller deals,

in part, and because our group was an amalgam of some ancillary groups from other departments, when I joined, a lot of people were really young. You could get involved in a lot of different field types. So it was trial by fire. I was not someone that had been in Warden doing Excel classes. Previous to work, I'd only used the Mac. I could barely use Excel. I was great at back-of-the-envelope math, but that was about it. So

He was really trial by fire and trying to play catch up.

But in our group, because it was such a lean team and because the folks were young, you were thrown into the deep end and told to figure things out. I think my second or third week in the job, someone handed me a stack of papers and said, "We're buying four aircraft from American Airlines. Figure out how to get the deal done and close it." Now, the deal was signed. They'd agreed on a price, but there were logistics to be dealt with, with coordinating transfer of title with the FAA while the planes are on the ground, in between flight.

coordinating with tax counsel that were 30 years older than me and spoke some foreign language, yet still in English, and all the little considerations and

the guidance was figure it out. And so it was just spent a week pulling all-nighters, reading everything, asking a million questions. And on the other side of it, you feel a little more confident about the next deal. So pre-GFC, that was a really exciting way to learn. Debatable how great that was from a risk management perspective for a regulated bank, but exciting way to learn. Our group did great. We were super profitable for the firm, I think, in and out of the downturn.

And so then what happened through the GFC in what you learned about what you hadn't known previously? I think the mantra of our group generally was don't lose money. So every deal was first underwritten like a debt deal. Our group was doing both public and private investing. I would spend all my time in private investments, but debt, equity, and a lot of things that were in between, JVs, minority deals, et cetera. And our capital was using the firm's balance sheet. So

firm would allocate some amount of dollars, it would get levered 8 to 15 times, and then we'd put it into companies. And so

always the first set of questions around committee were, where's the risk exposure? How do you lock in some basic return? And then how do you create some really interesting risk-adjusted return? So deals that might only yield 10% or deals that are the potential to yield 30% were all weighed with consideration for the risk. Even when things were heady in 2007 and before things started to really fall apart in 2008,

That was the mantra. And I remember us losing out on lots of opportunities because folks were so downside oriented. It ended up being a blessing in disguise or as intended. It was formative to initially, but then when we saw things fall apart in terms of liquidity, just entirely leaving the market through the GFC, it really hit home. And focus on how you find multiple ways to de-risk, multiple ways to take your capital off the table, right?

And then also hopefully multiple ways to win and win big if you can. That stayed with me into personal investing, into my time at my own firm,

And then we were in an interesting seat because as certain funds had to dispose of assets in the face of 2008, 2009 liquidity issues, and even banks disposed of assets, we got a look under the hood of a lot of these guys. And so we got to see what a lot of folks had done wrong. Really interesting position to learn from others' mistakes. What mistakes did you see at the time?

that you weren't from in that period. We saw people doing minority deals without any real protections or some set of rights, but no clear form of enforcement of those rights and no game plan or instrument in place where if they needed to effectuate some sort of right they had underwritten and relying on, they could do it. There were debt deals that we saw that were underwritten, assuming

just the next guy would pay a higher price and the game of hot potato would play on. But there was no real focus on a liquidation or workout. So when the rubber met the road, there was little you could do. Today, we spend a lot of time in financial services and I spent a lot of time looking at financial services businesses. One of the things that stuck with me was having a business that is entirely reliant on

dirt cheap, consistent debt financing from a bank is really risky and particularly risky if you are sub $200 million market cap. So a small gust of wind, a small hiccup, and we saw this with SVB and FRB, et cetera, can just render your business completely insolvent. So

My big thing today is really how does this business and how does this opportunity make a lot of sense on a completely unlevered basis? That makes sense to bring in leverage. Great. It's icing on the cake. It can be an accelerant. But can we build the business in a way where debt market can fall away? Lender may not renew the modest amount of debt that we've taken on and we'll survive and do great.

So you were part of a long line of people at Goldman in and around different parts of the capital structure that ultimately left and formed their own funds. I'd love to hear what your thinking was at the time of how you progressed and when you felt like you were ready to launch. So...

My path is a little different than some of the other guys that left. They had been working there 10, 15, 20 years. They were partners. They left with backing of a major asset manager. Mine was a lot scrappier, more entrepreneurial than that. Mine was a few years after the GFC. It just became really tough to do small deals. Number of committees had grown. There was more pressure to write checks that were larger, that were worth the

time and effort to justify the incremental bureaucracy and additional scrutiny we'd get around tier three assets. And I like small deals. I thought small deals were more intellectually interesting. I like things that didn't fit, weren't cleanly defined, that fell through the cracks somehow. And

love the fact that you could find a business at the right moment, even as someone that was young, but someone who had studied that industry, small but pithy insights could actually make a difference in the business's evolution versus a billion dollar market cap company where there was a little I could add value to in terms of the CFO or the go-to-market strategy or a connection that I could make

And intrinsically, that was more interesting to me. And those deals were less efficient. Just you could get way better pricing. So I wanted to put my money in that. I left really because I wanted to experiment to see if I could get small deals done. They couldn't happen at Goldman. My plan was really, there were a few families that had said that if I found deals, they would fund them.

scroll forward, ended up working with an entirely different group of families to fund. I had enough money saved up and earned that I felt comfortable taking a risk. And I was excited about a lot of relationships with potential portfolio companies I'd built up during my time with Goldman. At Goldman, we're doing very industry-specific, vertical approach to sourcing. So build a point of view on a subsector, build relationships within that subsector, and

get entrenched in the ecosystem and then wait a few years till someone wants your help and capital. And maybe overly confident, I thought I could translate that into a few deals. And I left. And my thought was, if it doesn't work out, I'll go to business school. My first office was the print center at Staples, two blocks from my house that I would skateboard to in the morning because I had to get out of my apartment.

My next office was subleased space in Nine West, so figured out office space. But it was really scrappy early beginnings driven by my interest and desire to get involved with these small businesses. So what happened when you launched? You had a few families you thought were going to back you that didn't. You were looking for deals. What did those initial years look like? At the start, the goal was find a great deal.

build relationships with initially family offices that love to fund one-off deals and see if I could pair the two together. And the overarching theme in finding deals was, how do I find something that is truly proprietary where I can justify my place in the capital structure versus another firm? The way I did that was similar to how we approach investments today. So develop sector expertise where

board and management don't feel like they're educating you where I'm not necessarily telling them how to do their job, but I may bring insights or connections or network to the table. I think the second is be really solutions oriented. So today at Thayer Street,

We're focused on businesses in the lower mid-market that are somewhere between a conventional debt investment and a levered private equity investment. So we're investing in the fat middle part of the capital structure. Sometimes it's an unlevered investment. Sometimes it's a super bespoke preferred security investment.

and took that same approach when we were doing one-off deals. So it was cases where someone didn't want to sell the company, they wanted to minimize dilution, they would give up some equity, they didn't want current paying debt. There was an opportunity to structure something interesting and differentiated. The idea was leverage the relationships that I invested time and effort into and effectively structure something interesting and

Because of some of the goodwill I built up, management teams and sometimes existing owners were willing to give me a little bit of time to put together the capital because I was pretty upfront with them.

Very quickly, there were a few families that more materially aligned with our business and began to fund all of our transactions, even though they were still case by case, slowly and kind of organically built a team. So when you were starting out, you said you're young, you're getting going, you're trying to be scrappy. How do you go about building the right relationships so that you can get your way into deals that

I'd say when we were doing it then, it was, again, pick a theme within those focus sectors. Usually that theme is going to be the result of being on the right side of ongoing increasing regulation, consolidation in an industry, or adoption of technology.

and just map the market and be dogged about meeting everyone and be comfortable getting lots of doors slammed in your face. So finding warm connections for introductions, cold emails never worked for me, meeting people at conferences, meetups, referrals from larger funds where they thought they saw an interesting deal, but it was too small for them to invest in. So they referred it to us. But when we were starting, a lot of it was

attempt to meet with and build relationships with hundreds of people and get rejected by most of them. So it was just getting really organized and really intentional around the companies that we met where there was connectivity and where I believed we could truly add value beyond just writing a generic check.

What are the particular skill sets that you need on your team to be able to build relationships and then have the creative, structured finance piece that brings that together? I think there's two components. So right now, our senior team comes from similar backgrounds to myself. So they come from other institutions. Some folks have been at Coleman, but other institutional firms where they're

They're investing in the same business, financial and real estate services, combination of debt and equity, but they did it at a larger scale. So they're a part of roll-ups or creative financings. They have the real institutional pedigree to understand what good looks like, but they've

joined our team for that same reason, they find it more fun and rewarding to work in this part of the market. So having that debt equity lens is an important part of the team. Not everyone has it, but we have a mix of perspectives. And I think that's something that we're going to continue to focus on maintaining. And the other one is just being tenacious and dogged and thoughtful about research. So

Part of it is having the right idea. The other one is getting out there and listening and meeting companies and figure out ways to be collaborative and solution-oriented. And not everyone on our team does everything, but I think the combo today is what ends up being our secret sauce. So at what point in time, as you started having some success deal by deal, did it turn into being able to build a team and raising capital in a more traditional institutional structure?

Our first committed fund had a final close in 2019. So it was a good five, six years of really doing a deal by deal. Now, on the back part, we had a process, we had a team of five people, we had a lot of repeat family offices, high net worths, and even institutional investors.

But it took a while and frankly, we did it slowly because SPVs worked really well as a business for us. In order for us to level up our impact, retain really good talent, and also make it a little easier on our LPs, it made more sense to convert into funds. Having said that, still today, we have a pretty active co-invest component to everything we do.

As you crystallized the ideas you had into a strategy, how do you describe what you're doing at Day or Street? I think two sides of the coin. So what are we doing from a structure and approach perspective? And then what are the themes we're investing behind? So from a structure and approach perspective, we are doing proprietary relationship-driven partner deals where we are

investing either on a totally unlevered basis or in the upper half to upper two thirds of the capital structure in a manner where we feel we're relatively downside protected and collateralized by some underlying recurring revenue stream that could be subscriptions, royalties, leases, or other financial assets or a hard asset.

We're primarily providing capital to these companies for growth. So it's mainly primary capital, sometimes a bit of secondary. We're really not doing any buyouts. We've never been in an auction.

We are investing in businesses where we hope have really low correlation with the capital markets. So these are businesses that their in-place revenue is super consistent. So north of 90% annual gross retention, north of 100% year-over-year net retention, where these are businesses in financial services, real estate services,

business services that are going to keep operating like clockwork. And they have, through the recent tariff spikes, COVID, last several downturns, the key way to make money is can they either consolidate in a fragmented industry or can they grow organically in a way where usually they are selling some sort of product or services, again, in a fragmented industry, but they're selling that service to consolidators. So they're growing as a result of their client's growth.

Most of the securities that we're investing in are some form of preferred equity. So structured equity, senior preferred, convertible preferreds, participating preferreds. Occasionally it can hit the form of other stuff too. What do you find particularly interesting about the opportunities that you see in the strategy in the current market environment? Our mandate is flexible capital and structured equity.

What's interesting is it feels more and more like we're filling a void. I don't know if it's a full black hole, but it's definitely a growing void. So you have this massive growth and at the same time consolidation of non-bank private credit.

trillions of dollars being managed by a small number of firms. And in many ways, the growth of those firms is phenomenal, but it's leaving companies behind that need 20, 30, $40 million of debt. And it may not just be senior debt. It's MES, it's second lien. It's something that's a little more flexible.

and checks that size, your guys just can't afford to spend time on. Same time you see a continued pullback in what the smaller banks are doing. What's left is often really expensive or really rigid growth capital for these lower mid-market businesses, and it's not for everyone. Oftentimes, while our capital is a little more structured and a little more tailored,

We don't invest with back leverage. We don't require current coupons or current amortization. We're focused on the long-term cap gains event alongside management. So what we see is an opportunity to offer them best of both worlds. A little more upside preservation for them, but total alignment in that if they're winning, we're winning. And that makes us supportive of the right CapEx investments, people investments, M&A investments.

And it's actually folks who used to compete in that market and provide phenomenal solutions in that market are kind of outgrowing it. What are some of the themes that you're excited about today? There's kind of micro themes within each of the sectors that we're hitting on. Big picture right now, I think structured equity or flexible capital is really interesting in our part of the market.

for a few different reasons. The setup is intriguing because on one hand, in terms of credit, you see this tale of two cities. You see small and local banks providing debt to an increasingly de minimis portion of the

population of companies out there in the mid-market and small businesses. It happened materially starting the GFC, and it's accelerated more dramatically, typified after SVB and FRB, etc. And then everyone talks about how direct lending is approaching $5 trillion, and folks assume that that's serving the market that's less served by the banks. But the reality is,

80% of private credit is dominated by 20% of the players. They are investing out of very large funds. That market continues to consolidate. And the focus of most folks in direct lending and private credit is on opportunities that are larger than $50 million checks. It's $100 plus million allocations. So you have this piece of the market somewhere between $5 and $50 million that is not efficiently served in terms of flexible debt.

So that's one. I think the second is...

You have this array of fragmented, high-recurring businesses. And examples of some of these business models that we've invested in are sleepy license maintenance software companies that provide some sort of essential solution. Vertical payments companies that are very specified for a specific industry, and they have a ton of tailwinds because of regulation. Elevator maintenance, super regulated business. You have to maintain your elevator maintenance.

Elevator regulation only increases every year, regardless of who's in office. Elements of property management. Property management is 90% fragmented and owned by individual owners.

So these are companies that are small, midsize, and you have a dramatic number of these companies that are changing hands in the US today. So 70 plus million baby boomers own shy of 50% of the small businesses, and a lot of them are retiring and don't have a succession plan. So we're trying to find businesses that we can back.

back or consolidate alongside management teams that have crazy high recurring revenues that are super resilient. And they can grow by buying customers from folks that are retiring, or they can be the recipient. Sellers can contribute their businesses into a consolidating business.

And that company can get the benefit of all the contemporary tools that everyone in private equity is talking about software, AI, machine learning. But small little gains on those companies on that scale can drive really material outcomes. So that's the overall setup. Provide very flexible capital that's not buyout, that's not super levered and partner with folks to get exposure to those areas.

Once you've identified one of those, what's your diligence process look like? Our diligence process starts a lot earlier than the identification of a deal. Usually when we've struck a deal with someone or found a company that's ready to go, 80% of our diligence is done. We may not have a view on that specific company. Usually that company is one of many, and we want to have a view on that exact business model

its subsector and the broader ecosystem well in advance. So as a team, quarterly, we're doing deep dives on themes we want to invest in. And that research turns into a multi-year research project where we're tracking those companies, following them up, scoring them in our CRM, really dialing in a thesis.

Once we've identified the companies we like, and in some cases, it may be identifying the teams that we want to back running a consolidation play in an industry we like. There isn't a specific company. We're going to spend a lot of time getting to know folks. So there's a lot of dating before there's a proposal, and it's outside of a process. In some cases, it could be years of...

dinners, lunches, golfs. I don't golf. Other people on my team might be golfing. Referring clients, comparing notes, helping them iterate on a comp plan, and observing how the teams act through thick and thin, getting them to know us and our style. And so at the time when we're arriving at a transaction, it's really a conversation about structure and price.

After that, it's all about confirmatory diligence. So doing the QAV, background checks, reference checks, even though we've probably already referenced the business, really getting into legal tax and regulatory diligence. But it's very micro at that point.

And as a result, even though sometimes these companies are not totally prepared, they don't have a banker, they haven't done that prep work, we may be able to make the closing process pretty efficient because we're just focused on the confirmatory side. So I'd love to dive into that structure piece. How do you set it up to try to meet a certain risk-reward framework on each deal?

Every single deal is different. Big caveat. The way we think about setting this up is across our fund, we're trying to create a portfolio where the majority of our capital at risk from an underwriting basis is within the credit envelope. So if it were a different portfolio and a lender looked at it, they would say, hey, 80% of these dollars are dollars I would take risk exposure in a loan.

The second from a portfolio approach is we want to create some sort of minimum return. Again, not every deal has it, but some sort of minimum return. So on a blended basis across our portfolio, we have some sort of downside protection beyond capital preservation. In the case where the company doesn't do as well, we're buying businesses at relatively reasonable valuations or investing in them at reasonable valuations, but we're

If you have multiple compression, or more typically, the company just doesn't execute to the extent they plan on executing, there's some sort of hedge in us not having dead money on that return. So across our portfolio today, we have just shy of a 1.5x minimum return. We're trying to create this base layer where if none of the companies grow, they just stay stable, which is rare.

We're already engineering, call it a 10%, 12%, 14% IRR. Obviously, that is not what we're setting out to do. Many of our companies do 3, 5, 7X, but we're trying to create that downside risk mitigation. And then finally, we're going to think about how we actually get back our basis if things don't work out. So if the business is not

growing, how can we create a return? Is it through liquidating hard assets? Is it running off cash flow streams? Is it selling subscribers or customers that are easily portable to a third party? Is it a business that we know there are 20 strategics in the mid-market or large cap that already want to buy it and we can pass things over to them? With the way you structured positions and wanting to capture upside

Without necessarily needing to have the cash coupon, how do you blend that with wanting to make sure you have your downside protection if it's not coming in the form of cash? It depends on the deal. There are some deals that are minority deals where we'll be senior preferred, we'll have all protections around debt, major actions, budget approval, etc. And even though that minimum return is on an accrued basis,

on an exit liquidation event or some other form of liquidity, we're going to end up

earning, just based on that minimum return, something that's equivalent or materially in excess to where a conventional private lender is earning. And in fact, we're going to have a more efficient and faster means to protect against adverse scenarios than a lender might who can't be on the board and can't have certain consents around the table and can't step in and help when things go awry because they're worried about lender liability issues.

What's one of your favorite examples of a creative structure in one of your investments? I have two examples. One is we invested in a very entrenched payments and invoice and company. They did payments in the real estate and property management space, which is heavily regulated around tenant protection.

So historically, about 90% of landlords did not offer an electronic option. You had to pay by check. And there was a whole antiquated way of collecting and cashing checks so landlords could stay on the right side of tenant protection and tenant eviction laws. We have thesis in this. We went through our whole playbook. Stars align several years after building a relationship. And one company that we thought was great needed more capital. They didn't want to sell control.

They were approached constantly by smaller private equity players, and they couldn't take on debt because one of the reasons they need more capital is they need to have substantially higher liquidity and tangible net worth as required by some of their processing bank partners. So what we did was an interesting structured deal.

They were also dilution sensitive. So their view was their company was worth X. We thought if we had to sell the company tomorrow is worth 80% of X. We basically went to them and said, hey, if the company does not grow materially, we have to have some way we can make a respectable return. So we'll meet your evaluation, but we get our money back first before anyone else. We get a block on any debt. You can't lever the company.

we get another 0.8 times our money. And if the company doesn't grow materially in the next four years, we can exercise our right and we'll agree, we'll put the company up for sale. And so they were very confident they'd grow materially. Their view was that the company hadn't grown within three or four years, they would want to sell it anyway.

And on our side, we had a security where either heads, we make 1.8 times our money over four years. So mid-teens IRR. And our breakeven point was really we were investing in, we were around 20, 25% LTV of the company, if you were to do the data equivalent. And tails, we'd own 20 to 25% of the company. And we could make five, six times our money if it hit 20%.

numbers, half of what the management were projecting. That was a great win-win. They were able to get a deal from us that was way less dilutive than the other offers that they were getting. And we had a really interesting security where it fell in place just in line with those portfolio objectives. What ended up happening with the business? The business was able to execute relatively consistently with management's plan and

The big picture thesis was a really strong one. When you have people that live in multifamily buildings want to pay their rent electronically and the world was moving electronic and this is an area that lagged. Like most of our investments,

It's not about the theme. It's really about the execution on the theme. And they were able to execute. So that company grew probably 4x in terms of top line revenue and another closer to 5 or 6x in terms of gross processing volume over a four-year period, ended up getting bought. We took some stock. We thought there was a lot more to go. So we took a little stock in the acquirer and then the acquirer got bought. So everyone was happy.

What was the other type of example? The other type of example is a case where we've invested in a recurring revenue business where the entrepreneur is very averse to debt. They want every dollar of EBITDA or cash flow that they're generating to make investments in the business. And for whatever reason, they did not want to lever up their company.

They also felt that they could grow substantially more. At the same time, they knew they could grow at an accelerated pace if they had assistance with M&A. So buying a couple of their peers, competitors, or smaller versions of themselves that they knew would be instantly accretive if their customers were on their books. As a creative way to stair-step into that investment,

We've done a number of deals where we will buy either a little more or a little less than half of the company, but we'll do it initially through some sort of preferred security where we're paid back first in the waterfall plus a minimum return. And then if things go well, we'll convert that capital into common equity alongside of them.

The win for us was we're creating these securities at a debt-like level. The win for the seller or entrepreneur is we can be a little more flexible on valuation and they can preserve more ownership versus doing a conventional buyout deal where they may only retain another 10%, 20% of the upside on a go forward. The kicker on that was after we do that deal,

we were around the table to help them execute on a handful of M&A transactions. And we had more money that we could put behind that if needed. Those are great because most of our capital was going to things that are making the business worth more

the operator super bullish on their business and they want to roll up their sleeves and accelerate it more. And we can offer our investors this really interesting risk-adjusted security where if we kill it, they can make close to the returns that a buyout deal might make. But if the company is not as scaled as we hoped, ultimately, we have some return protection. What's happened when one of these doesn't go as you expect?

It's a good question. So just to back up, in most cases, we feel we're investing in pretty obvious themes. They're not necessarily obvious front cover of the Times or journal obvious. But if you're a student of some of these industries, they're relatively obvious. And if you're investing in these segments on the smaller end and they're buying smaller businesses, you're usually able to get a little bit of a discount.

on valuation, not insane discount, but a little bit of a discount. And there's room to drive efficiency either on the top line and the bottom line. It's all about execution. So the thing that happens most consistently when things go wrong is companies scaling nicely. The company goes from 30 employees to 100. And there is a new set of management issues, layers of the org chart,

an executive that's used to having control or being in the weeds in certain activities just doesn't have the time or bandwidth. And if they do, it's a totally bad ROI on their time. So the growing pains of going from a small business or non-institutionally backed business or a moderately growing business to a slightly faster growing business, that's where we see hiccups. Most of the time,

It's just part of the game and it's not a straight line, but hopefully it's a oscillating line that's still up to the right. And in some cases, teams can't handle it. And in those situations, we're collaborating with them in most cases to get off the train, so to speak, a little earlier than intended. The good news is usually there's 10, 20, 30 other players that

many of whom are larger, that want these customers. And the customer relationships are so sticky. These are businesses recurring it with 90 plus percent recurrence. We can still generate a lot of value on an exit or on an early sale to a competitor, to a larger strategic, or even a sponsor-backed business, even if it's not the ultimate outcome that we had all hoped for.

In some of these situations that aren't going as well, how do you think about trying to work with and support the management team to get them back on track? Upfront, we're going to work with the company in a few different areas. One is HR and recruiting and team building.

Another one is finance, infrastructure, and data. And then a third is around process, procedure, and redundancy in terms of M&A and M&A integration. Those are the three areas where we have the most value. And again, we're trying to invest in businesses that have a good thing going. We're not doing turnarounds. We're not doing repositionings. And if it's really dramatic a shift,

That's a case where either, hopefully in a really collaborative way, we're finding an exit strategy pretty quickly. So just dialing back to those few areas, the folks helping in those cases are a combination of our investment team as well as our operating partners. We have just shy of 10 operating partners. And these are guys that, for the most part, are former executives in the industries we're investing in. Some of them are former CEOs and CROs of companies.

portfolio companies we've had, a number of them are functional experts. We have guys that have led businesses in vertical software and in the real estate space, roll-ups of very small silver tsunami type mom and pop businesses.

We have some functional experts that lead or run HR and recruiting firms or have done operational either turnarounds or strategy repositionings, both at a small level and some at the highest level with much larger firms than us. So the idea is in the first year of an investment,

We're collaborating with management to really come up with a plan and execute on that plan to fortify what we think are the biggest risk areas or the parts of the business that we think are going to come under the most pressure. We're trying to identify companies up front where that's going to match with our skill set. Usually after you're through the first one or two year mark, the scaling risk drops down dramatically, at least in our experience.

How do you think about competing in this space? When you're trying to win a deal, how do you think about your positioning relative to other players? The good news is we're not doing tens or hundreds of deals a year. So a busy year is when we're probably doing five deals or so. That would be a high volume year. I think generally it comes back down to we want to find companies where we're

we have a reason to exist in the capital structure. We have a reason to exist because we have a lot of intelligence in the specific sub-industry the business is in, and/or we can be an accelerant to some vector of that company's growth. In many cases, it's a repeat of some analog that we experienced at a prior portfolio company. The way we compete is

A, find interesting businesses and themes we like where it has that overlay. There are a lot of situations where investing in new companies that have slight adjacencies to historical wins or existing portfolio companies. And another way we stand out was just flexibility and creativity around how we structure our deals. Someone who wants to minimize dilution but doesn't want the cash pay burden or restrictiveness of traditional private credit.

And they want to retain usually materially more upside than they would in a lower mid-market buyout deal. And then it's really about demonstrating our knowledge and potential value add. When you put these together, how do you think about structuring a portfolio? The shape of underlying deals could be a little idiosyncratic, but...

When we think about our funds, they are, call it plus or minus 10 positions, historically, maybe even closer to 12. Maybe we only have 10 or less outstanding at a given time. We have a high degree of recycling in our approach. So the way we think about it is plus or minus 10% positions at a max, one. Two, even though some deals may be

a preferred note with warrants or a convertible preferred or totally unlevered vertical strip of the capital structure, when you blend those all together, we want something where in a downside case, you have a structured return that'll be meaningful. It could generate in and of itself a low to mid-teens return where our risk exposure looks and feels like

attaching at 10% to 20% LTV and detaching at 60% to 80% LTV. So really upper to middle of the capital structure type blended risk. But we want sufficient optionality across the portfolio so that we can hope to generate returns that are north of a 3x or 4x growth. So blend those all together. In a base case, maybe that looks like we're an outcome of 3x or more.

If you look out a couple years and say you don't end up being close to that kind of a classic pre-mortem, what do you worry about in terms of either correlated risks or other things that could go wrong with the strategy?

I'd say something that's not specific to the strategy at all is just general liquidity in the market. As uncorrelated as the underlying businesses are and business models are, if we hit patches of pullbacks and liquidity, we're going to hold portfolio companies longer, have an IRR impact. Hopefully, there'll be a commensurate MOIC increase.

But I think that's a big risk. I think most of the risks, though, candidly, is idiosyncratic execution risk. There are a lot of benefits from evaluation and potential for efficiency perspective in these smaller businesses. And obviously, the capital structure positioning benefit is huge, but it's the underlying small business execution risk, which I think is really more idiosyncratic and case by case. And so...

In that situation, if we were unfortunate, that might mean that our returns are going to asymptote closer to that structured minimum return level versus the base or the upside case. That hasn't happened historically because the themes have played out and enough of the companies have executed. But it wouldn't be a calamitous outcome. We'd

be it returns that are equivalent to the S&P, historical returns in that case. As you look at your first six years as this scrappy deal-by-deal, the next six as an institutional manager, where are you hoping to go in the next six years? In short, we want to keep doing what we're doing. Started the business with the intent of investing in lower mid-market companies. It's just as fun, and I think we can add more impact today than we can before with all the learnings.

focused on continuing to do it in an even more dialed-in manner, our funds may grow a little bit.

We have a pretty material co-invest component to what we do. So that co-invest allows us to keep funding capital into companies that grow over a long haul. So the idea of sticking with our portfolio companies over a longer horizon is interesting and something that's top of mind to us. I think this pocket of the market and being a flexible capital provider is actually more interesting today than it was several years ago.

And our team's even better at executing at it today than before. So I want to do a little more and continue to refine the model. What are some of the business challenges that you face in trying to do the same thing a little bit bigger, a little bit better over time?

It's something we think about constantly. It's definitely not as straightforward and there isn't a clear analogy to copy from. I think the way we've tended to do it is finding people from the get-go who are excited to be involved with the companies and get the benefit of their growth, both directly and indirectly. So...

employees up and down our team are participants in carry or synthetic carry. Every single person in our team. One of the challenges sometimes LPs comp our approach to this to larger firms, which I don't think is fair or analogous. In an ideal world, everyone who joined us would evolve and grow with the company and be here for the next 20 years. I think the reality is given we're intentionally trying to stay small and focus on small,

there's just a limit to how much our management company and team is going to grow. And so there are often dynamics where certain professionals, investment or otherwise, are going to grow and evolve at a faster rate than our business can accommodate. My view is life is long. Business relationships are going to continue to evolve and exist while someone might be a member of our team and even after.

Oftentimes, we'll have junior and mid-level people that work with us. They're phenomenal contributors, and we find ways to continue to work with them outside the firm. We've even done deals with former employees. And so continuing that business relationship is not only the right thing to do, but it's a creative from a business perspective. Fortunately, our core senior team has continued to work together for the last many years, and I think that's going to stay consistent for the foreseeable future.

All right, Josh, I want to make sure I get a chance to ask you a couple of closing questions. What is your favorite hobby or activity outside of work and family? As a reform hip hop DJ, my favorite hobby is probably going to concerts. Second favorite hobby is after being injured in almost every other sport is hiking. It's one of the last sports I can do that are doctor approved. And I've become a pretty avid hiker over the last five or six years.

What was your first paid job and what did you learn from it? I had lots of traditional small jobs, babysitting, fixing computers, any little side hustle. My first paid job was actually being a

style and marketing consultant for Levi Strauss when I was 11. A stranger heard me talking and recruited me to do this job. And for about two years, I got assignments from Levi Strauss company to basically give them my opinion on lots of different ideas they put in front of me. Actually, the New York Times wrote a story about how it was child exploitation. I thought it was the greatest thing ever.

I guess what I learned from it was even people who are experts and are possibly the best at what they do only know so much. I'd sit around a table with all these adults I thought obviously had all the answers, and it was crazy to me that they didn't know everything. Which two people have had the biggest impact on your professional life? I'd say first one, even though he...

Doesn't work in private equity, let alone finance, probably my dad. He's a doctor. He's run and grown departments inside different hospital systems and then also independent organizations. The energy, enthusiasm he has towards growing teams and the sense of satisfaction and reward he's had to driving impact around building an organization and seeing that business grow

was and has always been inspiring. I see parallels to that when things go right with the companies we invest in. The other one is probably, this is a bit of a cheat, but it's probably no one person, but it's different elements and attributes of some of my colleagues at Goldman. So there was just a level of desire to operate at the most excellent standard all the time.

while being professional, that at least the people around me exuded and just a drive to be consistently great that has stuck with me. And that was an approach to everything, whether it was communication externally, underwriting, or other business or software activities. It was real and it stuck with me. All right, Josh, last one. If the next five years are a chapter in your life, what's that chapter about?

I think the chapter is about bringing our firm, Dagger Street, to a different level of driving impact and helping portfolio companies. I'm excited that we've dialed in a really specific model for investing and a model for helping portfolio companies. And we just want to do more of it. There's been a lot of phenomenal learnings. And I think this is a great moment in time for us to put it in action in an even more material way.

Josh, thanks so much for taking the time to share the story of what you're doing at Thayer Street. Thank you. Thanks for having me.

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