I came across an interesting podcast the other day, in which Brent Beshore the founder of investment management company “Permanent Equity” was being interviewed. He was discussing his firm’s approach to investing, and spoke in depth about one of the portfolio investments called “Selective Search”, which is equivalent to an executive search firm, but for romance.
As I was listening to the podcast, I thought it was very similar to the approach taken by the group I spent five years working with. Essentially permanent equity involves making controlling equity investments with own funds and very little debt, in sector agnostic companies which are held for a target period of 30 years. This compares with private equity which typically has a holding period of no more than 10 years. The fee structure of Permanent Equity is unique in that it aligns investors with the partners.
Brent started Permanent Equity as a small family office back in 2007. Some initial investments were made, which generated cash flow to enable the firm to expand organically. However, they needed additional capital to take advantage of more opportunities which could not be funded by organic growth alone. Brent was approached by an investor, who liked what they were doing, and offered to invest if they could agree on terms. Brent structured a partnership structure which enabled the firm to be disciplined buyers and long-term operators of sturdy durable businesses which compound returns over the long term.
He has recently raised his second fund of $300m, which is being invested into businesses that are a match for Permanent Equity.
“We serve sellers who care what happens after close, valuing organizational stability and long-standing relationships with employees, customers, suppliers, and their community. They want a fair deal with people they can trust to not break ties.”
Key characteristics of permanent equity investments
Sector agnostic – means they can invest across most sectors, although they try to avoid organisations that are dependent on a commodity or recent trends.
Geographic location – they only focus on companies which are headquartered in the USA, since they understand the country culturally and operationally.
Ownership profile – usually small family businesses, with shares closely held.
Low levels of debt – they do not use debt to finance transactions. This is in contrast with private equity which typically use high levels of financing, hence the term “leveraged buyouts”, or LBOs. During times of low interest rates this looked smart, but when base rates of central banks have gone from close to zero percent to 5%, highly leveraged businesses doesn’t look smart.
Ownership structure – they insist on buying a majority stake in a business, which can be between 51% and 80%, or even 100%.
Operational involvement – both the firm and the operator should feel like active owners, with both parties collaborating to make decisions relating to pace of growth, types of growth (organic or acquisitive), reinvestment in the company, and distributions to shareholders.
Long term hold – investments are made with no intention to sell, with a projected holding period of at least 30 years. This enables profits to be compounded over a long period of time.
Own funds – they use own funds, rather than having co-investments from other funds, or outside debt from banks. This enables autonomy over the way the business is governed.
Durable value propositions – investments are made in businesses which are likely to be around for years to come, rather than passing fads. When it comes to these types of businesses I think of Berkshire Hathaway’s See’s Candies, which was first started in 1921, acquired by Berkshire 50 years and later, and now over 100 years later still generates strong profits and cash flows for Berkshire.
Valuation – majority positions are usually valued based on 3 to 7 times free cash flow. I like their focus on cash-flow rather than earnings or balance sheet as a basis for valuation since cash-flow is less subject to manipulation and non-cash elements.
Differences between private equity and permanent equity
| Traditional Private Equity | Permanent Equity | |
| Fee Structure | Annual 2% of committed capital + 20% of returns above a hurdle rate | No annual fee. Earn a fee only upon distribution of cash to partners, in accordance with an agreed cash on cash return in excess of a hurdle rate |
| Debt Levels | High | Low |
| Investment period | 3-5 years | 10 years |
| Investment holding period | 10 years max | +30 years |
| Source of funding | Bank debt, equity, co-investors equity | Own funds |
| Sector focus | Usually focus on a select sector | Sector agnostic |
| Involvement from partner post close | Minimal | Usually involved either with a path to retirement or long term involvement |
Advantages of permanent equity model
Patient investment structure allows for disciplined buying at the front end and opportunistic selling at the back end – whilst private equity firms usually have a 3-5 year period for investing their fund, and a mandatory exit within 10 years of the fund going live, permanent equity has up to 10 years to deploy capital and 30 years to enjoy the compounding returns.
I recall from my time as an analyst in a private equity fund, we were looking to buy farmland assets in Africa during the period 2012 to 2015. This coincided with a bull market in agricultural commodities, and farmland prices were at record levels. However, fast-forward a few years and prices had fallen substantially. However, with the fund needing to deploy capital, assets were acquired at prices far above which could have been paid a few years later.
With its patient structure and without the pressure to deploy capital, permanent equity is not in a rush to buy, so it can buy assets at opportune moments. When selling, again PE firms may be under pressure to sell when asset prices are unfavourable, whereas permanent equity can wait until prices firm up. Brent talks of premature selling often considered one of the biggest drag on returns. Think of Ronald Wayne who sold his 10% stake in Apple for $800 in 1976. The stake would be worth $290 billion today. Early in my career as a stock picker, I recall selling a stock which had gone up double digit percent in a short period and thinking I had done a good trade. However, had I kept the shares for the long term, the returns would have been far superior.
Low debt means less risk and greater flexibility – unlike dividends to equity holders which are discretionary, a company does not have a choice about whether to pay interest on borrowings to banks. In a low interest rate environment, which we have seen over the past 12 years, a company may have a comfortable interest and debt service coverage ratio, but in times of rising rates, this ratio can squeeze a company’s cash flow considerably. In summary, low use of debt means there is lower risk involved generally and less chance of being pressured into making decisions which go against the will of the operators. Lower debt also means there is more cash to distribute to shareholders, rather than repayments to the bank.
Use of own funds mean there is autonomy to govern the business for the long term – use of debt, or even co-investment from other equity holders reduces this autonomy. When banks lend funds to businesses, there are covenants that dictate certain parameters that cannot be breached by a borrower, else the loan can become repayable immediately. Co-investors may have different values, ambitions and objectives which could be at odds with the partners. Together, these factors mean considerably less flexibility for owners to operate the business on their own terms.
Alignment of fees with investors and operators – partners only get paid when they generate above average cash-on-cash returns for investors, typically achieved through distributions from dividends, or eventually upon sale of the shares. If the investment manager doesn’t generate cash for their partners, they work for free. This contrasts with some fund managers who charge fees based on hypothetical asset values or mark to market returns. The misalignment of fees with investors is well spelled out by Fred Schwed in his popular book Where are the customers yachts? In contrast, the fee structure in private equity is based on a percentage of committed capital, which incentivises the repaid deployment and raising of capital as quickly as possible.
The operators are also incentivised based on cash distributions to investors. Naturally, when a company reinvests capital in projects, the investors are foregoing current cash returns, since surplus cash could be distributed. Only when the projects generate cash flow for distributions, do the operators get incentivised.
Involvement of operating owner post close – unlike private equity, when the buyer typically buys the entire company, permanent capital enables the owner operator to remain involved in the business. This may either be for a short time (legacy buyout), or a longer period (growth partnership). The willingness of the owner operator to remain involved post close can be a positive signal that the business is healthy, rather than taking their cheque and running for the hills. (asymmetric information means the seller has much more knowledge of a business than a buyer).
Types of investments
The majority of Permanent Equity investments are categorized into either legacy buyouts or growth partnerships.
| Legacy Buyout | Growth partnership | |
| Equity bought | 60%-100% | 55%-80% |
| Life stage | +10 years old | At least 3 years old |
| Discretionary free cash flow | $3m – $25m | $1m – $15m |
| Revenue | $10m – $250m | $5m – $75m |
| Operating profit margins | Demonstrated double digit operating margins | Path to double digit operating margins |
| Principals involvement | Up to 5-year path to retirement | Longer term involvement from seller. Plans to stay operationally involved and grow the business |
| Operational changes | Minimal – focus on releasing capacity constraints | More involvement |
| Location | North America | North America |
| Situation | Seek to transition ownership with minimal disruption to team, culture and customers | Seeking a partner and partial liquidity for growth |
What do the investors do after during and after a transaction closes?
Permanent Equity have the view that the owner operator often has a much better grasp of how the business should be run that they could ever hope to achieve. The investor doesn’t come in with a “100-day plan” which typical private equity has, trying to implement radical changes within a short period of time. The investment is typically made because of the vision of the operators. Using an analogy from Rumelt in his book The Crux, venture capital is invested not in business plans but in the individuals who have proposed the venture and have committed themselves to running it. Permanent equity is about backing the vision of an operator. In accordance with their “do no harm” approach, the investor first starts by absorbing as much information as possible about the business, secondly, they seek to understand the goals and any capacity constraints of the business, third, they agree on how the firm will grow, whether to build organically or acquire, and lastly, the pace of growth.
A key question the partners like to ask of operators, is “what could be invested in now that won’t pay off for 5 or more years, but will be meaningful when it does?” This enables the business to step back from the coal face, and think about creating long term value.
“what could be invested in now that won’t pay off for 5 or more years, but will be meaningful when it does?”
Application and lessons from businesses I have been involved in
I spent five years of my career working with a permanent equity structured business focused primarily on investing in Zimbabwe and the region. The way we invested was very similar to how Permanent Equity invests. A few of my learnings are summarized below:
Avoid minority stakes – as Brent talks about, owning a minority stake makes you subject to the changing decisions and values of your majority partners. Even a partner with 51% controls the business and may make decisions which are contrary to the values or aims of the investor. A situation with one of our investee companies drove home the value of having at least a 50%, or else controlling stake.
Long term partnership mentality – we partnered with a tourism business in the popular resort location of Victoria Falls. When COVID happened, the business had a cash flow crisis, since it would have no revenue for at least a year, but in reality it was about two years since revenues began to normalize. The business implemented massive cost cutting measures across the business, and we stepped in with a shareholder loan to help the business get through the worst of the nadir.
Sector agnostic – our group had investments as diverse as gold mining, grocery retail and wholesale, property development, clothing retail, appliance manufacturing, agriculture and agro-processing, dairy farming, corrugated packaging, micro and SME lending, and tourism. This provided the group with exposure to most sectors in the country, as well as a diversification benefit as the business cycle changed.
Operator incentives – our group had a partnership draw mechanism, whereby any form of incentive (salary or bonus) the operator received was matched by the investor in a pre-agreed ratio. Often this ratio would be in the operators favour, rather than strictly based on shareholding, because the operator did the day-to-day operational work. For example, the shareholding ratio might be 50/50, but the draw ratio might be 60/40. For example, if the operator wanted to pay themselves a bonus of $100,000, it would be grossed up by 60%, so $167,000, and the investor would received 40%, or $67,000.
Initially partners were often uncomfortable with this mechanism, since the prevailing view was they did all the work, but over time they saw the value add from us and bought into the philosophy. One of the businesses that I was involved with involved an operator who was a minority shareholder, but had total operational control, an unusual situation. The investor didn’t receive any returns for more than 10 years after investing, and I am still not sure if a dividend has been paid. Once an investment subscription has been agreed, it is quite difficult to change the terms of the investment, and how the business is being run. But this was a key lesson.
Leveraging experience, network, and knowledge – due to our involvement as investment managers across a broad range of sectors, we had a birds eye view of the lie of the country, a strong network and relationships. For example, this enabled us to assist our partner companies to raise debt funding from banks; to recommend talent to our businesses for hiring, or to find sites for our retail stores to lease.
Scale the team for operational support – it is critical that the investment team is scaled to meet the operational support needs of the portfolio companies, rather than to bolster capacity to do deals. This is a key difference with private equity, where the focus is more on deals than operational support. In recruiting members of the team, the focus should be on how a new team member can add value to an investee company operationally, rather than being in a head office position. During my experience with SSCG, what often happened is that new team members ended up being seconded to work with investee companies and often took a permanent role there.
Further questions for Brent Beshore
A few questions I would ask Brent would be:
How is the investment team at Permanent Equity incentivised
What hurdle rate is used, and what is the performance fee charged by Permanent Equity
What is a fair hurdle rate What types of investors are happy to lock up their money for 30 years, and what if an investor needs to liquidate part or all of their