Daniel: Just to be clear because I can say this now, you know, we told our investors, “We know exactly what we’re doing,” you know, we told the partner we knew exactly what we’re doing. Oh my gosh, we barely, barely knew what we were doing, if at all. But it is probably one of the most rewarding moments, you know, that first time you have to stand in front of the company and be like, “Hey, I’m your new fearless leader,” and inside, you’re just terrified.

(intro)

From SMEVentures, it’s the Search Fund Podcast, a show about hungry entrepreneurs who, instead of starting a business, decide to buy one. These are their stories of success, failure, and the lessons they’ve learned.

Jake: This is Jake Nicholson of SMEVentures and on today’s show, we’re joined by Daniel Muzquiz, one of the entrepreneurs behind The Predictive Index, which he acquired with his partner after about six years of trying to buy it. And this wasn’t his first deal, since launching his search fund in 2002, he and his partner have acquired and operated three businesses, one after another.

(interview)

Jake: Daniel, thank you so much for joining. As you know, I operate on the other side of the world and there are searchers all around the world that are looking to people like you for guidance and inspiration. Your willingness to volunteer your time to talk with me is much appreciated.

Daniel: Of course, I’m glad to be here. And I’ve lived in quite a few places around the world so I’m very sympathetic with how the US is different than, you know, the rest of the world.

Jake: Yeah. So, Daniel, you’re an engineer by training. You got your degree in mechanical engineering from UT Austin. Was being an engineer like a life goal for you? How did that come about?

Daniel: No, I was kind of the first one to go to college in my family so I think my family was just happy I got to college. Didn’t really know what it was but I did like working on old cars and I thought “mechanical” sounded like something you might work on old cars with. Turns out I was wrong. It has nothing to do with that. And I’m just thrilled that I did the degree because I think mechanical engineering, in all seriousness, just helps you see problems and solve problems in creative ways. You don’t often think of engineering as creative but it is surprisingly creative in how you can solve problems, you know, kind of going through all the myriad of the degree.

Jake: And you’ve seen those skills transfer to your subsequent business life over the years?

Daniel: Yes, yeah.

Jake: You graduated UT Austin in ’94 and then you go to work for a company called, am I pronouncing it right, Nabors Industries? Which I admittedly had never heard of before.

Daniel: Crushed it, the first one was much better, Nabors, yes —

Jake: Nabors? Okay. You were there for almost five years as the company’s youngest country manager. Tell me about that experience.

Daniel: You know, back then, in oil and gas, probably still applies now, is there was kind of a dearth of younger talent that kind of brought in some fresh perspectives, etc., and it was great. I went to — put into situations that most people would only dream about or see in movies, you know, whether it’s running operations in Colombia or Mozambique and, as the country manager, you just get to see everything. So it was a great experience. It’s the closest you can be to a CEO but the buck doesn’t really stop with you. It stops with you in country but, you know, you can always call and get more money from headquarters if something goes wrong. Yeah, it was a wonderful experience.

Jake: How did you get that job? Country manager straight out of undergrad sounds pretty impressive.

Daniel: Well, I mean, I worked my way up to it. I remember using it as a test interview because I was like, “I don’t wanna go to oil and gas,” and the guy that was interviewing me goes, “Hey, if you show that you can step up and work hard and learn to be a manager, we’ll just keep promoting you until you fail,” and I was like, “That sounds challenging, let’s try that.” And so I started out digging ditches straight out of college on a rig in Texas, which was miserable, and just kept working hard until you just get promoted, promoted, promoted, then pretty soon you’re in a spot where you’re like, “Dear God, what am I doing? Not sure I’m capable of this,” but it’s a wonderful learning experience. Not necessarily my industry of choice, but great learning.

Jake: Your next step after that was Harvard Business School, presumably because, what? You wanted a step up or a career change? What was your thinking there?

Daniel: Yeah, career change was primarily it. I think I had wonderful mentors when I was at Nabors, like just really great people, but I realized there’s probably more than just kind of on-the-job learning and I wanted just more structure learning, just wanted to think of the world differently, just realized how little I really knew of how the world and economics and truly businesses work so figured I had to go to this schlocky school in Boston, give it a try, and they let me in.

Jake: So, you finish up at Harvard, have your MBA, you take a fairly traditional post-MBA path initially. You took a job at BCG, common choice for top-tier MBA students, but you were only there for six months. Had you already thought about doing something else beforehand? What happened there?

Daniel: Yeah. So, you know, in business school, I was so isolated, you know, growing up in Texas, family’s from Mexico, I didn’t really have exposure to how the world worked in, you know, kind of these higher fancy echelon parts of the business schools in the world. So I tried investment banking and, dear God, that was certainly not set up for my approach and so decided to do BCG and get exposure to different projects, be around really smart people, and it was wonderful. But after being operating for a while, I appreciated that, you know, providing really smart answers to people I didn’t find as rewarding as implementing probably less smart ideas but actually implementing them and seeing what actually happens when you put them into practice. So, I decided to transition out of BCG and my first boss there when I went and resigned, was our first investor and I give BCG a huge amount of credit and particularly a good friend of mine, J. Puckett, for kind of giving me the confidence and the support early on to support a, you know, young kid transitioning out of BCG.

Jake: And just for context, you know, if you look at that Stanford study, you see the trend line, the number of search funds launched per year going more vertical by the year. You finished your MBA in 2001, launched your search fund in 2002, do you know about how many search funds were being launched by then? What did the ecosystem look like?

Daniel: It was nowhere near as robust it is now but I remember when we were launching people were talking about how popular it was back then so I think every year it feels like more and more get launched and then they think of the prior years as a small market. So, even when we were launching, they were like, “Yeah, back in the old days,” and I guess now we’re the old days. So, there was a few but the ecosystem didn’t have any of the support infrastructure they do today. We used to have to call and try to talk to, you know, Lev Grossman or somebody to get some insights of what was happening back then.

Jake: So, you were an operator. You went to business school, you had a little taste of consulting, you wanted to get back to operating, you decided that search fund would be a good way to do that, then you launched your search, you raised your money, launched the search, we won’t go through that, at least the fundraising process, but I wanna hear about the search experience. By all accounts, from the searchers I’ve spoken to over the years, looking for a company to buy can be quite an emotional journey. Was it that for you? And, if so, how did you manage that?

Daniel: That was probably the most unexpected part, particularly early on, and we started going through it and we reached out to some other search funders who were, you know, a year or two or three ahead of us and they provided some really good insights because I think I was probably struggling to deal with the emotional ups and downs and this great friend said, “Hey, look, you’re gonna have some good days and some bad days and some days you won’t know if it’s a good day or bad day so it’s gonna be like highs, lows, and unknown days during the search and you’ll get home and your friends will ask you how was today and you won’t have any idea if you made a step forward or backwards,” and that search process, it really happened to us many times, like, “Hey, here’s an interesting one, it looks good,” you dive in and it turns out to be kind of not so good. Or vice versa, you find one that’s really exciting then they’re already in their LOI and getting ready to close and you missed it and so the emotional rollercoaster was really tough but what was helpful is to know that that’s normal so that when you were in the lows or the highs, or the “I don’t even know if I should be happy or sad right now,” that that’s okay. That’s how it’s supposed to feel and that really gave you the permission to accept those emotions and keep your head up and, you know, just keep moving ahead to the next day. And that’s one reason I love having a business partner is because I’m a really passionate person and it’s nice to have somebody there who, you know, balances you out when you’re either too excited or you’re not so excited.

(break)

Jake: Yeah, so let’s talk about Mike. How did you find him and have you been together through this whole journey or were there breaks?

Daniel: Yeah, so Mike Zani, I call him Z so if you hear the name Z pop up, same guy, we were section mates at business school and he was an operator in kind of small manufacturing in the US. I was an operator, you know, externally, more services business. And so we always talked about doing it but neither one of us had a lot of money. You know, we didn’t come from wealthy families. So, when business school ended up, we were like, “Yeah, this would be fun to do but we need to pay student loans.” We both went to consulting and, at the end of it, we decided, you know, yeah, this consulting thing, it’s like I’ll quit if you quit and so we both quit and started our first search fund, kind of jumped off the cliff together and did our first search fund together in a very traditional way. And then the second search fund, we were geographically incompatible. I was down in Texas, he was up in Rhode Island so I partnered up with another good friend, another business school grad, and we did effectively a search fund, a modified search fund down there and then Mike did a modified one up in Rhode Island. And then, just recently, in 2015, we decided to get back together again because we were in between and said, “Hey, we had so much fun together, why don’t we do it again?” So Mike and I are now back together as partners, been that way since ’15 and it’s just a blast. It’s good to have friends to share the life experiences with and if you share the economics, who really cares?

Jake: That’s one of the big questions that I often get from people is I see that the Stanford study shows incremental statistics are a bit in favor of partnered searches and so they ask themselves, “Should I even do this without a partner?” so they pull their hair out trying to find a partner. What would you say to those people?

Daniel: Get a good one because you’re gonna be in emotional situations, friction-filled, high passion decision-making moments where you’ve gotta have a good foundation of trust to know that the other person’s coming from a good spot so that when you do feel like wringing each other’s necks because you’re all stressed out, that you find ways to make it through those things. And there’s a lot of tools out there, like the company we announced, Predictive Index, whether it’s Myers-Briggs, it’s not a bad idea to use those things because that emotional, understanding each other’s behaviors goes a long way to preventing unneeded conflicts if you can be de-friction it by understanding who that person is, not just what their resume is.

Jake: Yeah. So let’s talk about that first deal, LEDCO. Presumably, this was the first company you had bought for yourself, correct?

Daniel: Yes.

Jake: You never bought a business before, you found some money, decided to go look for a business to buy. How did you know that this was the one, never having done this before? How did you think through that process and know that you needed to act on this one?

Daniel: Well, you know, Jake, that’s probably one of the areas that we struggled with quite a bit, our risk profiles were slightly different and as much as our risk profiles were different, the way we talked about risk was different. And so we’d run across companies that one of us would be excited about and the other one wasn’t and one of the best things we came across is Mike’s business — not business, Mike’s wife, I should say, sorry, Conley, her name is Conley Wake, she introduced us to an acquisition framework that I think Bain uses so congratulations, Bain, for the callout here, hopefully it’s not proprietary, where they used a really simple model which helped us decide which company to go after because there’s so many companies that you can go buy, the question is which one should you buy, and the framework they had is really simple. It’s like — it’s three parts: Do you like the industry that the company is in? Do you like how it’s positioned within that industry? And can you, you specifically, like me, do we have the right skills to add value to that company? And I’ll give a couple stories that highlights how those — that that was really helpful. We came across this one company which was like — it was women’s churchgoing apparel which had great fundamentals, particularly in the South. It was just like a great business, right? It was positioned in the part of the market that seemed like it was underserved, it had all kinds of good stuff, and then we got to the last one, it was like, “Can we add value to this business?” And if you ever meet Mike and I, you’ll appreciate just how not stylish we are and you’ll also appreciate that we don’t go to church terribly often. We’re like, “Can we really add value to this really cool company?” And we’re like, “No, we can’t.” And we passed on it, even though it was a great company. And then we’d run across other companies that we saw, there’s this one, it was a distributor in Atlanta somewhere and it was tight. Good position, you know, transportation and Amazon was kicking up and we’re like, “Oh, yeah, this packaging and shipping is gonna be big.” And the owner of this company had run that thing better than Z and I probably would for the next five years, if ever. And we’re like, “Man, we’re gonna pay top dollar for this thing and we’re not gonna add any value. We’ll be lucky just to not hurt it.” And so it also allows to pass on that one but then when it came to LEDCO, you know, it was kind of in the technology, mobile technology space. We liked it. It was really well positioned, had some big fancy clients, and we looked at it, we’re like, “Oh, we can definitely see lots of operating and strategy and moves we can do to add a ton of value to the company,” and what’s nice is as soon as you check all three of those boxes, you don’t get caught up in all the minutiae of the deal. So many deals fall through because of some — what at the moment feels like a really important thing, whether it’s how long is the non-compete or “When can I talk to the customers?” or — but when you check three of those boxes and you say, “Yes, good industry, good positioning, we can add value,” just get the deal done, you know? It might not be the perfect deal but it allows you to know when to compromise and to compromise hard to get your deal because if those things are true, even if you pay a premium, odds are in your favor longer term. Sorry for the long story there, Jake, but that’s something we struggled with a lot because you will see a lot of companies, you’re never sure which one to pull the trigger on and a lot of search funders don’t ever get there because they could never pull the trigger.

(break)

Jake: So you successfully bought a business for the first time, now you are running a business you own for the first time. Day one, month one, year one, did you know what you were doing? Did you feel like you knew what you were doing? Or was it kind of trial by fire? How did those early days, early months go?

Daniel: Yeah, and just to be clear because I can say this now, you know, we told our investors, “We know exactly what we’re doing,” you know, we told the partner we knew exactly what we’re doing. Oh my gosh, we barely, barely knew what we were doing, if at all. But it is probably one of the most rewarding moments, you know, that first time you have to stand in front of the company and be like, “Hey, I’m your new fearless leader,” and inside, you’re just terrified. But it is so exciting. It is so rewarding. You have opportunities to learn more things than you thought you would ever learn in what it really means to own an operating entity and everything around it. The first year is just so rewarding. Frankly, every first year is just a blast. All kinds of stress but so much fun because everything’s new and shiny and you don’t have all the baggage so you’re willing to break sacred vows and change things and it’s just — and screw stuff up and you’re willing to work crazy hours because you’re all excited about it. It’s a blast, the first year. Stressful, but a blast.

Jake: And what did LEDCO do?

Daniel: Oh, yeah, so LEDCO, we helped bring the ruggedized mobile devices into emergency response vehicles, police, ambulance, fire trucks, those sort of things, so we would bring computers and printers and those sort of things and put them in vehicles so they could operate more effectively in the front line. So it was a good cause and that’s what we did and we had a great success with it. I mean, you know, people look at us and go, “You way overpaid for that company,” but we grew it at an average 45 percent CAGR every year and had a great exit and, did we overpay for it? According to everybody else, but we added a lot of value to it.

Jake: All right, briefly catch us up on the last 19 years. Or, I guess, not the last 19 years but the last 12 years since you left LEDCO —

Daniel: Well, thanks for calling me old there, Jake. Appreciate that.

Jake: It’s wisdom that we’re looking for.

Daniel: [inaudible]

Jake: Yeah. Involved in multiple companies. Was this all under the Phoenix umbrella, Phoenix Strategy Investments? That was your original search fund, is that right?

Daniel: Yeah, yeah, we kept Phoenix around. It still is around and it’s really more of a brand as much as anything because we do the investments directly through our investors and our own capital. We don’t actually use Phoenix as the investment vehicle. It’s really there as the, you know, the face so people understand what we are. Yeah, and so the second company — I’ll talk about mine and you can interview Z some other time, he can tell you about his but —

Jake: Sure.

Daniel: — after we sold the first one, we really had the luxury of saying, “What do we want to do? As kind of our legacy, what are we really passionate about?” And the first company was like, “Geez, can we even do this?” So we bought a good company but it really wasn’t as close to our hearts but we loved the operating experience and then we started buying companies that were about, “How can we kinda make the world a little better place?” and we actually tried to buy The Predictive Index, the company I’m running now but they weren’t for sale at the time, we got really close and they just couldn’t part with it so we bought a company in the education space and, again, I love helping people, help people on their trajectories. I’m the first one to go to college in my family so it was something that meant a lot to me and, ironically, you’ll like this story, we were competing with a bunch of other people, some small private equity groups and actually like three or four other search funders were actually in this particular deal, I don’t know how, that rarely happens —

Jake: Yeah.

Daniel: — we didn’t really know until the end, and we ended up buying this tiny little company but it checked the boxes. It was in a great industry, you know, education, knowledge economy, things moving forward. It was, you know, well positioned, had a lot of good contracts, good pristine —

Jake: This is ExamSoft?

Daniel: ExamSoft, yeah, and, you know, we could add a ton of value to it because they were thinking of it like how do they make money with it and our business model is not how do you make money with these companies but how do you create value, which is very different. So we go to our investors and say, “Hey, this company is making lots of profit, just get ready, it’s all gone because we’re gonna just invest in growth, in value,” so we tend to underlever and overinvest in the growth levers and you do that in some of these smaller companies, if you get the industry and the positioning right, you can just get outsized growth returns. And we added a lot of value, grew that company great, it was a ton of fun. And that’s when we got introduced to the SaaS business model, which I tell you is a nice business model but the prices are crazy when you try to get in and grew ExamSoft and ended up selling that one at some point when it was time for our current investors to realize return.

Jake: That strategy of underlevering and really reinvesting in growth is somewhat atypical in the search fund world. Was that difficult for you to sell to your investors? Do you think you would have been able to do that if this was your first deal or do you think you had some more flexibility because you had a successful deal under your belt?

Daniel: Oh, yeah, the first deal, it was much harder to make that social contract, right? With the investors. It slowly evolved there because we got growth rates up and cash flow sort of decreased, the people were like, “That’s a lot of cash flow growth,” and so we slowly earned and proved ourselves out that we could convert free cash flow into growth. So the second one is stupid easy. I tell you, after you have your first win, the world is so much easier to operate in. And after your second win or third win, it’s stupid simple to raise capital and buy companies at that point. And then this model is kind of the social contract we go in out of the gate with people and they’re on board with it and they’ve seen us be successful with it and I do think it is an underleveraged strategy for small businesses because they’re almost always a small part of the TAM so it’s really about grab more of the TAM, that’s where your value is gonna come from and I would argue that search funders’ time is more important than anything so, you know, go create something big if you can. If it’s not your first deal, make it your second.

(break)

Jake: So you came across this company called The Predictive Index some time while looking for your second company, second acquisition opportunity. Couldn’t buy it then but then you did. How did that come about? Tell me about The Predictive Index. What does it do? Why do you like it?

Daniel: I’ll tell you the main reason we liked it is because we were using The Predictive Index at our very first company as a vendor because business school does not teach you really jack about how to actually manage the humans you’re gonna run across in the real world and this was a tool that brought in all these insights around how you manage people, how do you hire people, how do you think about job fit to their personalities, and so we just freaking loved the product. It added so much value to how we were running our businesses and in a space that they just don’t teach you about in commercial and traditional business or in business school and so we loved the product so much, we were trying to buy it from 2009 to 2015 and we finally were able to buy it. Actually, the last daughter of the founder actually said, “Hey, if Mike and Daniel are interested in buying the company, we believe they’ll take care of it because they’ve been talking about how much they loved it for years,” so we were kind of first in line and just said, “Hey, all cash offer, 30 days, name your price,” and we bought it. And, since then, it’s really about taking advantage of that last lever, which is industry is good, company is well positioned, now let’s add tons of value. And it was spitting off cash when we bought it. It was focused on value preservation. And we naturally have shifted that model to, you know, value growth. And, you know, when we bought it, it was doing, you know, $14, $16 million in revenue and, this year, we’ll get closer to, you know, almost $100 million in revenue. So, you know, find something you like, love the fundamentals, and then go add value. That’s kind of my advice.

Jake: What an amazing story and I remember visiting you guys at The Predictive Index a few years ago and you could just see from both you and the zeal and this — it was evident that you guys were having fun and it’s easier to have fun when the company is doing really well, which you guys have been doing, but I think it’s obviously more than that, you love the company, you love the product, you’ve built a culture there that has taken on your personality and, you know, that was tangible.

Daniel: Yeah, it’s great.

Jake: In 2019, I read somewhere that you had somewhere in the neighborhood of 7,000 customers. The world has taken a couple turns since then. What’s happened to that number of customers? Have you continued to grow despite COVID?

Daniel: Yeah, good news like literally last week, we crossed 9,000 customers so we’re still moving in the right direction. COVID did not help but it didn’t hurt that much. And the knowledge economy and having people work better together, hiring the right people, retaining people, helping managers be better leaders, all those things that we do as a platform, as a talent optimization platform, are in more demand now than they were even pre-COVID so we’re pretty bullish about where we’re at but, again, focus on adding value. Don’t focus on trying to make money, you know? Create value in the world and capitalism has a way of rewarding people who do that. So, that’s kind of our general take.

Jake: Where do you see yourself in the next 10 to 20 years? Are you gonna rinse and repeat? Are you gonna step back and become an investor? What do you think life has in store?

Daniel: With The Predictive Index, the good news is we’ve never had a company with this much potential in a market this big so I could see us with Predictive Index, you know, PI, we call it, for a long time just because the TAM is so big. I mean, you know, there’s branches on the tree that include going public, which I’m not nuts about but it’s a fun opportunity to take something and really make a little ding in the universe. So, I could see us being here for a while but I do love social causes, I really get a kick out of education reform, helping kids get educated. Again, being Hispanic and the first one to graduate from college in my family. I just love trying to unlock all the untapped human potential in our society and the world. So, my guess is I’ll be spending more time on that sort of activity than I am today, which is some but definitely not a preponderance. So, in 20 years, I’m gonna be old and I’ll probably be doing more of that. 

Jake: Oh, we look forward to seeing what you do. Daniel, anything else you wanted to add to listeners who are contemplating launching a search fund, particularly in new markets around the world, as this model grows?

Daniel: Yeah, having spent some time overseas, you know, again, from third world countries to second world countries, there’s so much value to be added in those economies and those places with just more modern business practices so I think it’s rife with the potential to really build some significant value for the local economies and the local people. I would say it is an emotional journey. There’s all kinds of complexities overseas you don’t get in the US but that makes even a better learning and exciting learning curve. And then, the most important thing, get good people around you. Just get good people around you, not just good at executing but good people. There’s no substitute for enjoying working with talented people. You know, we made that mistake early on and not for long because it’s — it really doesn’t work if you don’t have great people you work with that you — you know the company is getting better when you’re taking a week vacation after your first two years there, that the company is gonna be better when you come back versus you’re worried about it falling apart. So, those are a couple pieces of advice for all those people out there. And good luck to everybody.

(outro)

Jake: In 2019, The Predictive Index raised another $50 million to fuel its growth. And in the past two years, through the pandemic, it’s grown from just over 7,000 customers to over 9,000 customers in about 150 countries worldwide. And as you’ve just heard, Daniel and his partner, Mike, seem to just be getting started.

Thanks so much for listening to this episode. If you enjoyed it, you can find more at the searchfundblog.com or wherever you listen to podcasts. I’m Jake Nicholson of SMEVentures and you’re listening to the Search Fund Podcast.