The Gestalt Vision: A Third Way for Succession
In the summer of 2021, I was sitting on a patio getting a drink with a mentor of mine. It was a sunny day during the height of the COVID crisis, and we were talking. At the time, I was doing some work with a search fund, and he asked me about what the process was like. He had been thinking about selling his manufacturing business, but felt a serious sense of trepidation. The business had been in his family for three generations - his grandfather had started it with a partner all the way back in the 1920s. He told me about how, when he was a small child, his father would take him into the factory often, with the employees there playing equal parts as teacher and babysitter. His first job was cleaning parts on the assembly line, and he’d do it every day during the summer holidays as a high school student (he really wanted to earn enough money to buy a car, and his family wanted to make sure he worked for it). He graduated college and learned the ropes in various roles until, in his early 30s, his father handed him the keys and had him buy into the business with a loan.
To him, the business was more than just a way to earn a living, to generate cash flow, or to make a fortune by selling. It was something quasi-spiritual - a place that he had built and shaped which had also built and shaped him. He knew the story behind every scrape on the office table and the backgrounds of every person working for him. He regaled me with stories of the good times and the bad. Of times when they grew and times where he felt like they were a moment away from certain death.
His children, he glumly said, weren’t interested in running the business. One had gone to become an engineer and lived in the USA. The other, running HR at a larger company in Vancouver. He was happy they were living their own lives, but looking at the business he had built, he wished that his children could have been the natural succession plan - they had made it clear they weren’t interested. The legacy that mattered to him was not as relevant to them, and while he understood it, there was a clear sense of sadness there.
As we got a few more drinks in, he raved about the management team that he adored. He credited his GM, his plant manager, his head of HR, and his line supervisors as the driving force behind why the business had grown over the last five years, as he had slowly begun to step aside. He was excited that his GM could become the next CEO and believed that he would do an incredible job. The management team were extremely loyal, smart, hardworking, and important - both to the business and to him. It was very clear that, in his mind, he had the legacy planned out. That even if it wasn’t going to his family, he was able to share the company with many of the people who truly mattered to him.
Due to this, while he cared about the value of his business, it wasn’t the only thing he worried about. He knew that private equity had a reputation for ruthlessness when it came to post-acquisition growth. He’d heard the horror stories - management replaced, culture burnt down, legacy wiped, all to facilitate another sale within a five year timeframe. The prospect of that happening to his business frightened him. He cared deeply for his employees - many of them had been with him for years, if not decades. His GM had started on the floor at 18, went back to school in his early 20s while still working, and now, in his late 30s, was the right hand man. His plant manager had joined him in 1997 and helped him through the booms and busts that followed. The two were like family to him.
But he was getting older. He was in his late 50s when we spoke, and had experienced a few health scares. He felt stuck. On the one hand, he could sell his business tomorrow and fund his retirement (and, quite frankly, his grandchildren’s as well). He had been approached by a few M&A brokers, as well as some larger private equity funds. But he worried that he’d be “selling out” his people, leaving them up a creek without a paddle. He was also concerned about the risk to his business’ reputation and legacy. He told me that he had a recurring nightmare where he told his people that he was abandoning them.
To him, it felt like an impossible choice. Reap the benefits of what he’d built at the cost of some of the most important people in his life, or protect his people but forgo a proper payday after decades.
Years later, when my partner, Ken, and I started Gestalt Capital, this conversation ran deeply in my mind. It had planted seeds that would take a few years to sprout, but as Ken and I discussed what we wanted to build in Gestalt, we realized that we had both spotted the same dilemma that many Canadian business owners face. When we talked it through, we decided that we wanted Gestalt to offer a different path for business owners like my mentor.
We realized there were two widely available succession strategies that business owners in Canada could currently take:
The First Way: Family succession, whereby an owner passed the business down to a child or children. Something that had seemingly become rarer and rarer.
The Second Way: Private equity succession, whereby an owner sold the entirety of his ownership stake to a PE group, leaving behind the people and relying on a completely new group to manage the legacy (with short term incentives driving PE decisions).
Neither of these options seemed great for people like my mentor or for the many business owners who have spent their life building something they are proud of.
At Gestalt, we wanted to create a Third Way.
From Technology to a Third Way
Both Ken and my backgrounds are fairly unique for this industry - neither of us has a background in investment banking or high finance. Ken is an incredibly successful venture capitalist, and I have operated and invested in technology businesses for the majority of my career. It was this unique perspective on investing and partnering that drove what we wanted to build at Gestalt.
To understand that, let’s talk about venture capital and tech investing quickly. I once had a mentor, a veteran in the venture industry, who referred to venture investing as “cowboy ****.” I always appreciated that, because it often felt more true than not. After all - imagine trying to invest in a business based on the belief that the people pitching you can take on the monoliths in whatever industry they are targeting. Often, these companies were pre-revenue. Sometimes, they didn’t even have a real product in the market yet. You want financials? You’re joking. Key performance indicators? Nope. Long term client relationships or brand? The business is a year old.
So what did you invest in? What could you actually be certain about as a venture investor?
The founders and their team.
Fundamentally, venture investing was about backing the right people. You could look at some trends in the market, you could hear an exciting vision for the future, but the world changed, the market evolved, and the future is rarely truly predictable from the present. What you could speak to, however, was whether you believed this was a team that could execute at a high level. Whether this was a team that was resilient enough to roll with the inevitable punches. Whether this was a team that you could trust when things were going well and when things were not. And whether they were reliable, honest, and hard-working.
We had no interest in coming in and trying to run the business (to me, it’s the height of hubris to think I can take over a business from an operator who has been at it for decades). We certainly didn’t want to replace the people that made the business functional. Our goal, as investors, was to back and enable these sorts of teams - to help them build ever better businesses.
Turning back to the formation of Gestalt Capital, we realized that we were looking to do something very similar to our venture capital days. While we were interested in more traditional types of businesses - think services, manufacturing, distribution, etc. - and much less so in technology, we were looking to apply the same mentality we used in tech investing to the Canadian middle market. That is, we wanted to enable great teams.
This was the beginning of how we defined the Third Way approach that we take.
Doing Things Differently
So, let’s talk about empowering and trusting great people. At the core of our philosophy, it permeates everything we do. If you were looking to enable a management team (or owner) in a business, how would you do it?
You probably wouldn’t acquire on Monday and demand they trim costs 20% by the end of the quarter. You probably wouldn’t tell them that you intended to sell the business again within 5-7 years, and that you needed 20%+ annual EBITDA growth to do it. If I had to guess, I’d argue that you wouldn’t bring in a new CEO to run the business, knowing almost nothing about the culture, employees, clients, suppliers or environment. Or that you’d force acquisitions of only tangentially related companies to make sure EBITDA kept going up, no matter what.
Yet, everything described is exactly the traditional private equity playbook. It’s not that they’re malicious, it’s simply that they are incentivized to sell their acquired businesses within 5-7 years. They are aligned around maximizing one thing: short-term shareholder value. This is contrary to how many owners (and us) think about their businesses - long-term, with a focus on other stakeholders (e.g., employees) alongside the shareholders.
As Gestalt was coming together, we realized that in order to be good backers of great Canadian businesses, we needed to be long-term owners. We couldn’t focus on just shareholder return and still hope to empower strong management. We couldn’t be temporary custodians, holding for a few years before selling to the next group, and stay aligned with the long-term outcomes of the business. We couldn’t sacrifice legacy on the altar of short-term results.
We had to be different so that owners we admired would want to sell to us and work with us.
Defining the Third Way
As discussed above, we think of the First Way as family succession, and the Second Way as selling to PE and walking away. But let’s take a moment to define the Third Way that Gestalt offers to business owners. At its core, it means three things to us:
We enable management teams: when we buy great businesses, we are not looking to replace the team, but to enable it.
We are long-term owners: when we buy great businesses, we are looking to own them forever.
We protect the legacy of the business: when we buy great businesses, we want the owners to maintain skin in the game.
Let’s discuss each one briefly.
We enable management teams
As noted above, we invest when we find a great business with great people managing it. We like to work closely with the business owner to ensure that the next generation of management is able to continue to grow the business. The flipside is that we don’t usually look too closely at businesses where there is no solid management team to take over post-investment.
To enable a management team, we stress the importance of long-term thinking and planning. It allows for both a consistent strategy and a stable environment for the employees, customers, and overall brand. Management and other employees must feel secure that things won’t change on a whim, and we ensure to keep that stability.
We are long-term owners
This long-term thinking and planning approach only works because we are long-term owners. We are very patient capital. When we acquire companies, we are acquiring for the long haul. We do not have a 5-7 year mandate to sell the business we acquired for more to generate returns so that we can raise the next fund and do it again. We are buying to hold forever.
Because of this, we don’t think in terms of quarters or years, but decades. Our goal is that the businesses we acquire will still be market leaders in 30 years. We will never make short term decisions that generate long-term harm, and are incentivized heavily not to.
We protect the legacy of the business
The result of a long-term ownership approach that enables management is that we end up being very protective of the business’ legacy. After all, if we are buying a great business and looking to enable management, we certainly don’t want to destroy what made it special in the first place.
Part of this is that we very much prefer situations where the people responsible for the legacy stay somewhat involved, engaged, and immersed in their business. As such, we generally prefer owners who want to maintain a piece of the business post-transaction. What that means differs by company and by owner, but it could be anything from staying on with a substantial chunk of equity to manage the day-to-day operations of the business, to transitioning into a primarily strategic role, taking a board seat, and helping facilitate an ownership stake for their management team. Fundamentally, we are looking for partners who truly believe in the Third Way approach and care about protecting their business’ legacy.
Let’s Talk
To close off, I think I’ll just reiterate that we love to talk to owners who are looking for a Third Way. If you are the kind of owner who is reading this and nodding your head in agreement, we are always happy to chat. Maybe there’s a deal to be made, maybe there isn’t, but we never say no to an introductory conversation.
Alongside that, we are very open to conversations with management teams looking for help with a management buyout, or to younger operators who have a small business but are looking for support in acquiring a larger competitor and running it.
