Episode Transcript
Hi, this is Andrew from XO capital. Today. I'm going to be talking about maybe having a thesis for our acquisition group. So at XL, we buy small profitable SAS companies and take them over and operate them.
Today, we're going to be talking about a thesis. I don't know if it's quite a thesis thesis. Isn't the right word. If you look at some of our previous posts, I don't. Have one necessarily for XO, it's been a lot more opportunistic. There's plenty of reasons for that. But. In theory, we're supposed to be buying boring SAS businesses that.
Cashflow slowly and consistently. On the small end of the market, it's just really challenging to do that. I mean, if you buy one company that's making five, $10,000 a month, you really just can't staff it very well. There's just not that much money to go around. And so we have a shared services model. So for our current portfolio, we've done seven total acquisitions.
We currently have four, so we've sold off three. So we're actively operating for. They're all product led growth type companies. Now. But it wasn't always that way. So we had bought a small B2B enterprise SAS company. In this case, it was an X, Y Combinator startup that just failed to hit scale, but was generating some revenue. And we, we took that over. So as an example of how challenging it is to do this with enterprise SAS companies,
This particular one was called work cloud. It's sold its product was for doing inspections. So we were selling to manufacturing companies, companies that made, you know, engines, et cetera. So when people first hear the concept of private equity or even micro private equity, that's what they think we do. And they're not wrong, but it's not quite right either.
In this early stage, right? So that company was making about a hundred thousand dollars a year when we bought it. That cashflow was also lumpy. So it wasn't like we were getting, you know, 8,000 some odd a month. It was, it was very lumpy. So, you know, We might get zero. For three months, right. And then a larger check for another month. So managing cashflow on these things is also like, not maybe as straightforward as it looks, because when you go into Stripe or whatever, and you look at the MRR number that is not necessarily the amount of dollars you're going to get that month.
Often case, or oftentimes it's, it's not even close to the numbers that you're going to get that month. But in terms of operations, that enterprise SAS company, we needed to handhold a relatively small number of customers. So let's say there was under 10 customers. Each one of those was a high dollar amount.
But if any, one of those turned, it was really, really bad for the business, right? That, that was a, that was a bad day. When one of those customers, churned. On the flip side, getting a new customer like that. That's in five, six figures a year. Is awesome. But they require a lot of touch. So Danny had to spend and was spending an inordinate or disproportional amount of time. Talking to these guys relative to our product led growth companies that had more of a freemium model. So you could sign up, there was a two week or 30 day or whatever free trial. And a certain percentage of those convert and that's kind of how those things run. The PLG companies are much easier to operate with a shared services model. We can have content. So people doing content for us.
We can have engineering. So all of our engineers happen to be in south America. And they are. Switching between portfolio companies and working on different tasks. We of course try and optimize this a little bit, but for the most part you know, they, might've spent a few days doing working on one product and then a few more days working on a different product and they get to, they have to context, which a lot, which.
In some ways it's fun as an engineer working on that thing. I always liked that, but you definitely do lose some efficiency when you have to, when you have to switch. So back to the thesis, you know, even, even on sales cycles And the enterprise SAS companies that process can take up to 12 months. It's just like a really long sales cycle.
So. You know that that's that's obviously not as good as some of these product led growth companies where somebody might sign up and pay that same day. Right. That happens all the time. So. And in certain ways, our thesis or this, this kind of maybe thesis is really looking for where we're going to be finding alpha, given that we are buying really, really tiny things.
A lot of these problems go away. If the enterprise company gets a little bit bigger. So in enterprise SAS, if it's making a million dollars a year and let's say there's really high margins, you can actually start to staff that. And the second that you can hire a CEO, like buy a company, hire a CEO staff, individual people just to work on that company.
I think a lot of our problems are the problems that we've been having in terms of like shared services, et cetera. Go away, obviously other problems arise. I'm not saying that's easier in any way, but it is different and it is not as the, the, the restriction on, on. How many people we can hire to service, how many companies that sort of math goes, goes away once a we can.
Effectively staff accompany even minimally, right? Even, even being able to buy a company, put a CEO in place, have one engineer and one, I don't know. Growth person or whatever customer support or whatever that business needs. Even that would be a radically different model than how we have to operate today. When buying these really tiny businesses.
So back to the thesis, we're looking for alpha. So alpha, if you don't know, is sort of like the excess return or the abnormal rate of return. So in normal private equity stuff, like let's say we're buying. Boring, you know, Quote unquote, boring software companies or enterprise SAS companies or vertical SAS companies.
I wouldn't say that that's, that's relative, that's relatively low alpha compared to what I'm about to talk about. The expected return is not that you're going to you. Of course could. But the expectation is not that you're going to a hundred X this or a thousand exit. The idea is that these companies produce consistent cashflow and grow at a consistent rate.
That is maybe a couple percent month over month, which over time compounds and is a totally lovely way to build wealth. But that is not quite the. That is what I thought we were going to be doing. And that is not actually what we've been doing. If I look at our history and our current portfolio.
So when we're buying these PLG companies, let's say they have a hundred customers. You don't really have to have any kind of relationship with them. Right. You only hear from them when something's going wrong. Are they. God, for some reason, these European companies just demand invoice, invoice, receipts for everything, and they just cannot figure out how to go and get them themselves.
So, but you know, outside of that you relatively. On a relative basis, you don't hear from them that much. Whereas some of these larger enterprise customers, you might have like a shared slack channel and be chatting with them all the time. And the expectation is if they ask for something.
You're going to go build it. The surface area of those enterprise SAS products is, is quite a bit larger than these product led growth companies that we've bought. I like to describe the ones that we have and the ones that we're looking for currently as they have kind of a single promise to the user.
So they kind of do, they're like a one trick pony. They do one thing. They do it super well. They might be go really deep on that one thing that might be, you know, there might be a long list of things for that one promise to be delivered on effectively a lot of features in that area. But generally speaking, there's a kind of clear end of to where the, the, where the product ends. Whereas with enterprise SAS, not always clear.
A new customer might have an ad hoc integration. That is required. Et cetera. And that might be specific to them. It might not be, but it's often the case that with an enterprise SAS company, the thing could, you could be working on that thing until the end of time. Right? And in many cases, a lot of these companies do, they have a lot of engineers.
Constantly building features or new integrations, et cetera. For these enterprise SAS companies. So. I overestimated at the beginning, how well we could execute on the enterprise SAS playbook. We're bootstrapped. So we don't have any investors. And it's just the reality of it is that we are not able to really effectively.
Execute on that. The PLG model with shared services works much, much better.
So the other side of this, between some abstract concept of a thesis and what we could actually execute on comes into play when we start looking at what's actually available for sale on the market today. So if you go on acquire.com and you go and you, I dunno, put in some filters for some kind of revenue range of the things that you could possibly buy, there just aren't that many of them.
So for us to also further cut down on that number of available opportunities, based on some thesis makes it really difficult to actually get any kind of volume of deals done. On an annual basis. We started with a really tight thesis and searched for four months without buying a single thing.
Because it didn't fit the thesis. We missed out on some opportunities that we could have just bought and I think they would have turned out quite well. And as soon as we relaxed that we ended up buying three, quite close to each other in, in. I think within two months we had bought three. They have relatively little to do with each other. And that turned out to be fine. And since then we've been operating on a much more opportunistic model. So our kind of buy box, these things are generally under 10,000 MRR. We're looking at stuff that's much bigger, right?
Some stuff that's doing 30, 40, 50,000 a month. But generally speaking, they're run by one or two people. They've probably been bootstrapped. And that's sort of, that's sort of our buy box. So. To say that we buy, like, you know, quote unquote boring businesses. I wish we could say that. I think that that's really cool. I just don't think we have the war chest to really execute on that because again, we'd have to be buying stuff in the low seven figures.
I think we could do one of those deals, but it would prevent us from buying additional companies for a long time, we would be, we would kind of just be having that one massive whale in the portfolio which is not necessarily a bad thing, but when I look at what the opportunity is now, because I think that we have an interesting play with buying. These small product led growth companies. Again, founded by one or two people. They're not even really full-time on these things a lot of times, because you know, The dirty secret of getting to 10,000 and MRR for a SAS company, is that at least if you're living in the U S that's not enough after taxes, after expenses, after some contractor fees, you just.
You just don't have enough. I don't know. Maybe I'm in LA I'm in LA. So maybe that's just why those numbers don't work. But it's just not that much money to be able to live off of. And so a lot of times people will sell because they. What to move on to something that's venture scale and go raise venture, or they have a full-time job and, or other projects that they want to focus on.
So that oftentimes is why they are selling this stuff. So notice so far in this, this whole thesis conversation, I haven't really talked about innovation. I think for us, for XO at the moment, we're not talking about anything. That's going to be, you know, landing on Mars anytime soon, we're not looking for a thousand extra turn with these bets.
We're looking to get a profitable, we're looking to get break even on our cost structure currently. And you know, Above all. I'm trying to make sure that Xcel is unkillable. And I think once we have a diverse portfolio of cashflow and companies that is at least break, even if not slightly positive XL becomes unkillable in the sense that.
We're not going to run out of money. Which is a huge killer of, of any kind of any kind of startup is, is running out of money. Now whether we can end up generating excess cashflow and being able to buy more businesses. You know, that's kind of what we're, that's kind of what we're looking at above the profitability and breakeven angle, we're trying to figure out how can we get this flywheel going of buying businesses that cashflow enough to start building up a cash basis that we can then go use to deploy and buy further companies.
You know, Danny pointed out a few months ago that constellation software its growth. Was mostly through acquisitions. Growth by acquisition, in my opinion is growth. So from our vantage point, it's been easier for us to think about acquiring an additional $10,000 of MRR versus trying to grow our portfolio by that same amount. Whether that is just a restriction of our current portfolio companies, I'm not totally sure. They each all make around 5,000 a month. And you know,
Interesting that they are all kind of stuck at that, that point. I'm not sure if that's a market thing. I don't know if that's us. I don't know what that is, but it would be much easier for us to just go buy $10,000 of additional recurring revenue. Bye. You know, buying a new company, then it would be to increase
To get there by, by growth on our existing portfolio.
So after about three years, we are not looking for enterprise SAS companies. We are looking for these little product led growth companies. Our highest alpha so far has been on taking bets like with cold DM, where we bought it for a few thousand dollars, it was making peanuts. And now we've 10 X it already, and it's making a few thousand a month.
That's where our highest alpha has, has come from is taking those bite sized bets running our growth playbook and kind of seeing what shakes out. So that type of thinking sounds and feels like venture.
The only difference is in our case, of course we're not finding founders and investing cash. And then you know, that's kind of the, the business model. That's, that's not really what we're doing. Right. We're buying the thing. And taking over operations.
So if you asked me a month ago, if I had to pick one area where we could only buy products in, I would have said sales tools. Even today I still think sales tools are a great place for us to start. They tend to be easy to get customers for relatively high churn, but you have a community of people that are willing to try new things.
Generally they're in sales or they're founders, or they run an agency. They try a lot of tools. They pick what works best for them and they kind of stick with it. Sometimes they will turn, right, like, so on, super send, for example, it's a cold emailing tool. They people come, they have some idea. They want to test it, that it doesn't work or, you know, and then they, they kind of turn, but then three months later they have a new idea. Come back, try again.
There's a lot of that. So on a, on a relative basis, I think sales tools have slightly higher. I don't know, let's call it structural churn than maybe some other industries, especially compared to those enterprise SAS companies that I mentioned are boring. Enterprise SAS companies. But still, I think they're there. They're plenty good businesses and they're, they're relatively easy to start and get up to a few thousand a month. I mean, for us,
You know, after, before we're cloud, we were making about 26, 27 k a month. After work cloud, we're making about 15 to 20 a month. And so, you know, we're not talking about huge wins that we need to get to break. Even at which point we can start to make more interesting bets. However, after thinking about.
What is an emerging technology where we could actually get even higher, alpha than taking these bets on these tiny SAS companies that we could pick up for, you know, under 10, 20,000. I think. You know, I'm, I'm looking at like many people are large language model enabled or generative AI enabled applications. I I've been in, I've been doing stuff in machine learning for a long time. And I really do feel like this time it's different. These tools are just so immediately valuable. And immediately useful that I think the hype is real and it's worth. Investing in and having some bets in this area so .
Circling back around, what does this mean for us in a, in a real practical way? One, I think we're going to continue to be opportunistic to, I think we're going to continue buying product led growth companies over. More enterprise SAS looking companies. That being said, if a cool enterprise SAS company comes along, I think that it would not be out of scope for us to just say yes to that knowing better what we're getting into now than we did previously and how operationally intensive it can be. I think we'd be.
At least better prepared mentally. And we have some tools at our disposal. Now we didn't before. To be able to handle that a little bit better, but a strong preference for product led growth companies. Third. I do believe that we should be making vertical bets. In the generative AI space. I think most of them will go not necessarily to zero cause these, again, I wouldn't say that we're going to be making venture bets, but I do think.
Hundreds of millions of dollars of value is, has already been created. If not more. And will continue to be created in this generative AI space. And I want us to have some irons in that fire. And. I don't know that that means we'll be buying all of these types of tools. It could be that we build some of them too. I know that that might be slightly confusing giving that XO is a micro, private equity company. We're supposed to be buying. We're supposed to be buying software companies, not necessarily building them.
However, I'm a software engineer and if I can build something for us for free, and it only takes me a couple of weeks. Then that is another way for us to get some alpha. That is another way for us to win. And frankly, at this stage, I don't really care that much, how we win. I just I just want to get there. And if that means we have to deviate from buying SAS companies to building some, to get there, then, then Soviet.
So I hope you enjoyed these mandarins on our non thesis thesis. If you want to read more about what we're up to and our current thinking on. Micro private equity and building and buying a small portfolio of SAS companies. You can check us out at notes dot echo dot Capitol. And thanks for listening.
