Hello, everyone, and welcome to episode number seven of Risk Playbook. I'm Mike Mitchell, Vice Chairman of Graham Company, and today I'm joined by Mike DiPiano, Co-Founder and Managing General Partner of NewSpring Capital.

Headquartered in Pennsylvania, NewSpring is a leading private equity and venture capital firm focused on the mid-market with over two and a half billion dollars in assets under management. As NewSpring has grown, it has transformed the course of many companies, partnering with nearly 200 businesses since its inception in 1999.

Mike is a serial entrepreneur and investor who has put Philadelphia on the map by driving innovation and infusing the local startup ecosystem with much needed counsel and capital, now regularly competing with Silicon Valley and New York City firms for investments.

Companies that NewSpring has invested in, and those that Mike was closely involved with, went on to be acquired by Citigroup, IBM, Capgemini and ADT – and that's just a small sample of his past portfolio successes.

Mike is also the Chair of the University City Science Center, an organization focused on commercializing technology, deploying capital to healthcare startups and acting as a convening body in the West Philadelphia region.

I first met Mike when we were just beginning our careers 30 years ago, and I've witnessed his success along the way. Mike isn't just incredibly smart, he's also a good guy who is humble, common sense oriented and down to earth.

I'm eager to speak with him today about analyzing risk when investing, creating winning companies and being a truly effective leader. I also know our listeners will walk away from this discussion with new insights that might help them make their own businesses better.

Mike, it's a pleasure to have you as my guest on Risk Playbook.

Thank you, Michael, nice to see you again.

Absolutely. 30 years, man, I'll tell you what. It's hard to believe. Time flies when you're having fun. And as I say, the older I get, the faster time goes. I don't know what to think.

Oh, boy, I totally agree. It's hard to believe, Mike, but I do remember. You don't look much different.

No, no.

I know I do.

I don't know about that. Let me start off and dumb it down a little bit – let me oversimplify what I think your business is for the audience benefit. Private equity, venture capital, my oversimplification is you want to invest in companies that you think you can scale and make better and more profitable, so that you can later exit and you can return capital to your investors? Am I right? Am I wrong?

Mike, you're spot on. And I would just say that could include lending money to one of those companies. It's certainly more often equity investing in those companies. And every now and then it also includes a publicly traded company that may be thinly traded, but does need capital to grow to build their business and strategic help along the way.

Okay, so let me go back to the beginning. It's interesting to me you started your career in corporate America. I know you worked for Baxter Healthcare Corporation in several Vice President roles. Today, it's an $11 billion dollar business. You went on to be a division CEO and Director of Chemical Leaman, which was the largest tank truck carrier in the country, transporting chemicals and whatnot. You had a successful career, and then you leave corporate America and you go into venture capital, private equity. How did that happen? What intrigued you about that?

The roots of that are really simple. My father owned a local service station. I loved being with my father, so I was always there. I sort of handled the outside of the house, the customers. He would always sort of deal with fixing the cars and so forth. And there were a number of customers that came in and I, in talking with them, would learn what they did.

There was a particular customer that had a number of cars come in regularly. The cars were just really nice, Mike. I just finally asked, I said, ‘What do you do to effectively afford all this?’ And he said, ‘I make money when I sleep.’ I thought, well, that's a pretty good idea, right? And I said, ‘how do you do that?’ and he said, ‘Look, I have a business, generates a fair amount of cash flow, and I take that cash flow, and I invest. And there's this wonderful thing called compounding. As the companies grow, they compound their value. You're not paying taxes unless you sell your interest. Investing is a wonderful way to get to know people, to build wealth. It's also quite interesting, because you'll learn a lot along the way.’

I think I was maybe 16 when I had that conversation, and honestly, I never forgot it. I always thought if I ever had the luck to learn enough and get educated enough, if I could ever get into investing, I would want to do that. So, I always wanted to do it. The steps along the way were not intuitive.

When I asked that gentleman what he would do if he were me, he said, ‘I would learn how to sell something, because without revenue, you don't have much of a business.’ So, at Baxter, I was a full commission sales representative and thoroughly enjoyed it.

I finally got an MBA at NYU at the Stern School and just kept working my way into trying to figure out how to run businesses, operate them and ultimately invest in them. Then in 1996, I decided to try to do that full time. Thankfully, I had a loving wife who was very supportive, because it was quite a risk.

Well, first off, I love to hear stories from humble beginnings and how somebody goes from where they were to where they are. And hopefully, you're driving a nice car today.

So, talk about the risks, the personal risk of doing what you did. This is Risk Playbook. Once we get into NewSpring, I'll ask you about some risk profiles as well. But, just a personal risk at a young age, going from corporate America, good job and now all of a sudden, I’m going to do something different, where I'm going to be held accountable if I make some bad decisions, right? How did you do that?

First talk about the risks, there are three of them. One is your own investment, and you could lose whatever you're investing, in fact, it often happens. Two, if you're raising money from others, you run the risk of reputationally losing them their money. Nothing's more personal to somebody than either their family or the capital that they have, and they support you with it. But if you lose money, once or too often, it can be quite painful. Then third is just the personal feeling that you failed. So, if the investment doesn't work out, to do an investment usually takes quite a bit of passion and to support an entrepreneur failing is a miserable outcome.

But the question you asked was, how do we do it. My wife and I often encourage young teammates to think about this. We always live below our means. We didn't buy a new car every year. I mean, look, we had no mortgage, we had no car loans, we had saved some money and we invested that money, and it worked out pretty well. So, we had the wherewithal to try this for a couple of years, and God forbid, if it didn't work, we still had something to fall back on and we could start over.

So, being prudent and planful. We were planning to do this for almost a decade, and we didn't know if we could make it work. But we were thinking of it, and that meant living below our means. It was getting ready for it, Mike, and then we took the plunge.

As a startup company, I'm just talking about NewSpring, for instance, getting started, you have to raise funds, capital from friends, family, whoever. That must have been a real challenge. Today, I'm sure it's a lot easier. You have a 25, 30-year track record. Back in the day, what was the sales pitch there?

Well, I wish it were easy now. It still isn't. But I will tell you, you're right. I mean, we raised more money in a quarter now than we have raised in its entirety through 2006. That was almost seven years after we started doing this.

It's going out and meeting with people and putting it on the line, here's what we're passionate about, here's what we think can work if we do our job well. It's always “if”, what are the variables? We always want everybody to understand the risk that we're taking, and what could happen, but what might not happen. So, to be authentic, to say, ‘look, it might fail. But if it works, here's what we think the result can be for everybody. And look, you're going to have more noes than you have yeses.’ We still do, actually. But there are people that say, ‘okay, I'm going to bet on you.’ Just like we bet on entrepreneurs, people bet on us. And we were able to get enough of those people to say yes, that we had something to start with.

Then the question was, ‘can we make it work?’ Now all along the way we're putting up our own money, we put our own capital in side-by-side with our limited partners and take the same risks they're taking with our own capital. So fortunately, people were willing to bet on us. And it was small initially, and it's still small, relatively speaking. But thankfully, after 22 years, it's worked out pretty well.

Mike, when you look at companies, or they come to you looking for capital, as I understand it, you want to bring something besides money, you want to bring business acumen, ideas, innovation, so that you can scale the business, figure out a way to get more profit or EBITDA out of it, so that it's worth more a number of years down the road than it is today. Are there certain industries? Are there certain businesses? What's the profile where you really think you can make something better than it is?

Well, the general pattern that we see Mike, whether it's in the healthcare world, or the non-healthcare world, software, ecommerce, the types of companies we see generally have a pretty consistent pattern. The pattern that we typically see is that the company has an initial core competence and initial barrier to entry that's pretty interesting. It has one, maybe two, sometimes even three, really core senior executives. But it is typically undercapitalized, it typically needs to build out its C-suite, it typically needs to build itself geographically. So, we spend an awful lot of time on HR and an awful lot of time on the strategic plan and how to develop that.

It's honestly simpler than you might imagine. It simply gets down to execution. How do we execute or help our teams execute building their team, from an HR perspective, putting in good processes and procedures and training for those HR resources? How do we organize their financial statements so that the reporting illuminates positives and negatives so that we can make adjustments along the way? And then what's the strategic plan in order to execute milestones? Ultimately, can those milestones be executed in enough of a discrete period of time with a certain amount of capital such that the end result is a real good outcome both for the team as well as for the investors?

By way of example, if we invest in a company, and it doubles in revenue, but it takes an enormous amount of capital to do it, it may be a successful company, but the return may not be so good, and vice versa. So, all of this bundle of things that need to be executed sort of have to be synchronized together. But it's not that hard.

I mean, we see great companies with great ideas off to a really good start. And the pattern recognition that we bring to it can really help them scale and fulfill their dreams. But they're the leaders, they're the ones taking the biggest risks, they do it seven by 24. We help, we nurture, we play devil's advocate, we cheerlead, we do all those things, through the period of time that we're investors, and knock on wood, so far, the results have been pretty good.

You make it sound easy. And no business is that easy, but you're being humble.

So, part of the due diligence is to see if some of those things check the boxes and can project that it's going to get better. Once you make the investment, you go through the strategic plan, you help them with HR, you figure out the reporting systems, all those kinds of things, you don't run the company, but don't you have to keep your finger on the pulse to make sure they're moving in the right direction? And the ongoing counsel, that's really important, is it not?

It's 100% of the game, Mike, you're spot on. You have to be able to develop a relationship with the leader, the primary leader, and in some cases, a couple of other leaders on the team, where you can have a frank exchange, positive and negative. The result of that is you get to either confirming the plan and what's being executed or potentially altering it to get a better outcome. But it starts and ends with having a good relationship. That doesn't mean you're best friends, you may not do things socially, you may do things socially, I've had both. But you have to be able to have a relationship with that leader or leaders to really, really be frank with what's happening, and what you need to do to either continue what's happening because it's really good, or to make certain changes.

We talked about risk earlier. Let's talk about risk here. What are some of the typical risks you see that sometimes you can work through, sometimes the reward is worth it, sometimes, you know what, man we missed it, is it people? Is it outside influences? Is it the economy? Is it the product fails? Is it all the above? What are some of those risks?

Well, product market fit is a big one, right? If there isn't a good product market fit, and that's just code for ‘will it sell?’ Will the product or service gain revenue traction? Does it fit the needs of the market? That's a big one. Is the market big enough? You can build a business but if the market is tiny, the reward can only be so large. Another key one is the barrier of entry that builds to the product market fit, is it sustainable? Or is it easily sort of reproducible, or can it be destroyed by something else? Then you get to the bundle of unit economics, that is once you start generating revenue, is the gross margin you generate from it worth the cost of gaining that sale? So, sales efficiency metrics, like lifetime value, customer acquisition cost and those ratios really become rather important. Retention rates are rather important.

Then on the people side, probably the biggest thing I say that is a red flag is the three-letter word that can sometimes be so important, but can be so deadly – and that's ego. Leaders need a strong ego to take the helm, often in spite of a lot of evidence that would suggest they shouldn't be doing it. But when the ego becomes too much, they become too stubborn, they don't take the signals and adjust the playbook to get a better outcome. That can be really, really detrimental. You can really judge that when you see how leaders have built their teams, how they retain key people, how many years people have worked with them, etc. When you see a lot of turnover and a lot of disruption, that's usually not a good sign. It's a tricky one to judge.

Well, I think that goes to, in my intro, I said you’re common sense oriented and that's a common sense thing that sometimes you don't hear, but you're right on. Somebody's got too big of an ego and is too full of themselves, that's not a good thing.

So, I was reading one of your investments that I think you're going to exit at the end of this year, Avantus Federal?

Yeah.

Okay, so just for the audience benefit, a software firm, cyber solutions for the Department of Defense, Homeland Security, 2018 investment. Since then, four years, eight acquisitions, went from 12 employees to 1200 employees, according to what I'm reading here, and I guess this isn't confidential information, but you're going to exit for $590 million. That tells our audience a little bit about what you do. You make acquisitions, you find a market…

Well, that's an unusual one, it's a 17 multiple. We're going to make 17 times our money. I wish we did that every time, Mike, we really don't. But it gets back to everything we just talked about.

The gentleman that leads that company, we spoke to for a good 18 months. He owned his own company, he was 100% owned, it was maybe $4 million in revenue four years ago. But he was and is a spectacular leader, really bright. This gentleman was the first ever CFO/COO of Homeland Security. When Homeland Security was created, he in fact, under Tom Ridge, whom he reported to, created it. He merged 33 entities, TSA, etc., in order to create what we now know as Homeland Security, a Herculean task. There should be a case study written about it. You talk about fiefdoms and egos, he managed to pull it all together. And he served his tenure as CFO/COO of Homeland Security, and then went into private practice.

He built a company, sold it and got it to a billion in revenue. Then he decided to do one for himself. The other one he did with IBM, and we were eager to back him, we ultimately did, it was as easy of a decision as you can make, because Andy is just a terrific, terrific person and terrific leader. Yeah, he would find an acquisition more often than not, we could structure it, sometimes it didn't work. But we did eight of them, if I remember correctly, and the company at the end of our hold is going to generate close to $45 million a year of cash flow, and hence the $590. It's actually $600 million, there's a $10 million piece going to employees for retention. So, it's about a $600 million exit. It really worked out well.

Impressive, impressive. So now all you’ve got to do is get them to create another business that you can invest in, right?

That's what we're after. We're starting to talk. He's got to stay there a little while, I'm sure, but good guy.

Like you said, 17 times multiple, that's awesome.

Listen, every business, every team has a loss or a failure. Tell me about one that didn't work out so good. What happened and why?

Yeah, so I'll tell you about a couple that we liked and didn't do, and ultimately should have, in retrospect, and then there is one that we did, that hasn't worked out so well. And I'm the one that did it.

On the ones that we'd liked, there was a company birthed out of Israel, called Datorama. We really liked the company, it actually incubated one of our other companies, also an Israelian-based company. We actually were going to make the investment, ultimately backed out of the deal for two reasons. The price of the valuation got a little bit expensive. At that time today, it would not be deemed expensive as a multiple of revenue. And secondly, the founder's family wanted to move home to Israel – that was well before COVID and nobody was running a company remotely at that time, and he would be one of the first people I would have worked with running a company remotely. I had a bit of an allergic reaction to it. Ultimately, we passed and the company was sold for about $600 million four years later, which would have been about a 7x return for us. So, we should have definitely done it. The individual’s now on the board of one of my other companies, so we've maintained a relationship. We really think the world of him. He still is in Israel.

Another one was Gopuff, a local company here in Philadelphia. We looked at it, thought it was interesting, thought it was awfully low margin. We just didn't have the vision to see what it might become. It's become a colossal business. No doubt we had an opportunity to invest in it early in its day, when it was about $70 million in revenue. And today, I think its most recent value was $15 billion. So clearly, that was one we missed.

There was another company in New York that we did invest in, and it was all the rage, had a great CEO. Really interesting, but the macro trends that we were learning about were quite potentially problematic in a particular sector. I won't get into the industry, but there were some industry headwinds that were being forecasted by people that were experts. We did all of our diligence. We knew that. We candidly disregarded recommendations, made the investment and it turned out those experts were correct. We had to pivot the company. It did pivot, it has been successful. But the early capital that we put in is what we call washed away. We really won't get much return on that. The secondary pieces that we put in we'll get a very nice return on and we'll probably sell the company this year. The ultimate return will be 2, 2.5x what we in total invested, which is okay, but it's not what our investors pay us to get. They expect us to do far better than that. So that was one that is a subpar outcome. We've had a couple of those, not a lot of zeros, but a couple subpar.

The insurance industry, that's my business. I don't know whether you've done anything in benefits or property, but I do know you had a success story, I believe, with iPipeline, which was more the life insurance sector, correct?

Yes, it was, it was a big success and a lot of fun.

And that just makes it easy for people to apply for life insurance. It's all technology driven. Correct?

It is. That company, which was at that time, led by Larry Berran and a gentleman named Tim Wallace, two fabulous leaders, great people to work with, both of whom are now enjoying the fruits of what happened there. That company 12 years ago was $5 million in revenue. Larry and Tim had a vision of how to provide a suite of services that would pull together broker general agents with the carriers themselves. So, putting the application online, binding the policy, being able to access data when there was a claim made, etc. I'm simplifying it, but it also included annuities.

That company today is about $90 million of free cash flow, might be a little more than that. I know that's what it was doing last year. It's all recurring revenue, 100%, and it was sold for about $1.6 billion 10 years after we invested in it. It was just a fun time the whole way.

Most of the growth was organic, it grew organically about 37% every year. But we did do a number of acquisitions, including one in England, including one down in Florida to build out the suite of services, which had the byproduct of enlarging the total addressable market for the suite. And those guys just executed pristinely. Every quarter, they were basically on the objectives that they thought they would hit.

It was really easy to be a board member, Mike. I cheered them on, thanked them and that was about it. Tried not to get in their way.

You talked about the importance of a CEO, and you're Managing General Partner of your firm, obviously a great leader, it's a success story, NewSpring. Congratulations, by the way. It's awesome.

Tell me about your style, Mike, and also, the culture of the company – you have, I think 100 employees or more? Is there a training program to make sure that you're all thinking the same way, that you look at things the right way, how do you make it all happen?

I think it really starts with this selection process. Because we do have a very specific culture, Mike, I'm sure you have the same at your business. We're very much a transparent results-oriented place that wants to get the answers right, because once we make a decision to invest money, 80% of the risk you're going to take has been taken, probably, at that point. So, we're really about diligence, seeing market segments, etc. and business models.

Culturally, we're a place where we're fairly friendly, collegial, but really results-oriented. I mean, this is a full contact sport game that we're in, and we want to get things right. So, when we're interviewing younger people to join us or people that may want to join us from an operating world where they're a senior executive, there are a lot of questions that we want to get answered. How passionate are they to be an investor? Is this just a sideline gig for them that they're interested in spending a couple of years or do they want to make this their life's work? We're fairly serious. We bias ourselves towards people that want to make it their life's work, really want to learn, want to hone their skill, want to get better at it. As a result, the selection process has worked out well.

Training, honestly, I'm not so sure we do a great job of it. I think we're better than we were at doing it. We now have training programs. Honestly, we didn't have them for about 10 or 15 years. We started putting them together as we grew.

But one of the things I'm proud of, we've had very little defection, very few people have ever left the firm, no partner has ever left the firm voluntarily. So, it's been a group that's been together now for a long time, a lot of people have been here close to 20 years.

So, you advocate, maybe even expect, require, perhaps, your people to be investors?

They're all investors.

Wow.

It's required. That’s part of the culture. Look, we're putting our money right with our limited partners, side-by-side. Skin in the game.

I love it. I love it. That gets people's attention, and that tells your investor something, right?

Yes. It's not for everybody. When we're talking to people that have been in operating worlds and they're used to stock options, and they say, ‘oh yeah, you get a check but you’ve got to write a check.’

You're going to test people's mental for sure.

The economy, the future, what's that? Do I hear interest rates rising? That affects valuations. You hear inflation, all sorts of things. Slow down, what do you see and how's that going to affect you?

It's definitely going to depress exit valuations, so, Mike, it already has. If a company was worth, pick a number, eight times before, it's worth something less as a multiple now. Most buyers are using some form of debt to acquire companies so that's more expensive, all that flows downhill and negatively impacts multiples. We haven't seen much revenue degradation in most of our companies. We have seen a little bit in our ad tech portfolio, where brands spend a little less to go secure customers than they might have done previously, but it has not been dramatic. On the revenue generation side, we haven't seen as much of that. We saw in COVID, when COVID happened, revenues dropped 30-40% almost overnight in some of our companies, and then they rebounded quite quickly a few months later. We have not seen that sort of dramatic change – in some cases, no change whatsoever.

Now, on the flip side, making investments, it's a better time, because again, valuations are lower than they were in the past. That said, multiples and valuation changes for entrepreneurs, their memory is most impacted by what they saw a year ago, and what the IPOs were then, and less so what they're seeing in the market now. It takes a few months for it to sort of continue to impact everybody. But I do think you'll see that the third quarter investment reports will be a bit less velocity than they were earlier in the year, that is less investments. I think that's going to mean smaller evaluations in the fourth quarter and first quarter next year. So pretty good opportunities to buy into companies in a really nice timeframe. 

Well, let's hope whatever slowdown we get, it's a small hiccup and not something that's protracted.

Yeah, we agree with that completely. It feels like it will be. The average tenure of a recession in our country has been 10 months. There have been a couple longer, ‘08 was longer, Great Depression was longer, but the vast majority have been well under a year. So, let's hope for that kind of a rebound.

Okay, I’m feeling better already.

Let me close out with something that I think is maybe near and dear to your heart, and that's University City Science Center. You're the Chairman there, and I know the advancements that the Philadelphia region is making in biotech is significant. Can you tell us a little bit about what you got going on there?

Sure can. You're quite right, the life science healthcare industry, throughout the city, and in particular, in University City, with all the breakthroughs, whether it's from Penn, College of Sciences, Drexel, etc., are profound. They're going to change healthcare for years and years to come, if not decades to come.

Look, the Science Center is a 60-year-old entity. It's a not-for-profit entity that was really birthed to provide a 30-acre parcel for this entity to develop, to do a couple of things, to provide a space for new companies to domicile at, to provide programming for STEM education, that’s science and engineering, math, etc. Today, we have a couple million square feet of campus. We're in the middle of building a new building now on 38th and Lancaster, so that will add to the footprint. There have been numerous companies birthed into or headquartered at the Science Center. The vast majority are healthcare and life science in nature. So, it has turned out to be everything the founding fathers of it wanted it to be. I've been a pleasure to be involved with it now for over 15 years, and Chairman of it for the last two or three, it's just been a really great time to be involved with it. It's a place where entrepreneurs can come to fulfill their dreams, meet other entrepreneurs and network, be mentored and mentor others, domicile their companies and grow and flourish. And it's just done all of that.

For me, there's nothing better than a successful leader that, number one, comes from humble beginnings, we kicked off with that, and the second thing that I love is when people give back. You're using your energy and your talents to help others in this particular space, and also creating a better environment for all of us, certainly here in this region. So, I thank you for your service in that regard. It's great.

My pleasure. The one thing we all have to do out of Philadelphia is trumpet our successes, we tend to be very hesitant to do that. And this city, when you look at it, is one of the greatest places to live and to build companies anywhere in the world. And you'll look at some of the resources, some of the opportunities that we have, and a great place to live. We throw snowballs at Santa Claus, and we don't do nearly enough, in football games, we don't do nearly enough celebrating our wins here. But we have the greatest media company, Comcast. We have great retailers, great software companies and unbelievable healthcare capacity and really continue to drive it.

Tell the audience, Mike, and I don't disagree with you, because I'm from here, but a lot of our audience is not necessarily. Why do you say Philadelphia is the best place in the country to build a company?

Well, first of all, it's pretty inexpensive. A, it's inexpensive to live compared to other regions. If you compare us to San Francisco, Boston and New York City, our housing costs, etc. are just significantly less. You have access to technologies that are unparalleled, whether it's engineering or healthcare. Penn, for example, is the largest recipient of NIH grants in the country. So, they are generating technology after technology, whether it's in healthcare, robotic software, etc. Drexel is doing the same thing. And they're just two colleges, two universities locally that are doing it.

Then you have access to other corridors. You have access to New York, Boston, you have access to DC, and by the way, it's an easy flight over to Europe. So, if you want to access that marketplace, you can get there.

Then you look at the HR talent. There have been so many massive corporations that have made this area their home, that have spawned executive talent, that are now thinking about becoming entrepreneurs, right? They've done a great job for 15 or 20 years in big companies, they want to go grab the brass ring because they have an itch. So, we have a plethora of talent that is out there.

It's just a unique place. Now, it could have a more entrepreneurial bent to the region, right? There are a number of us that are focused in that world. But to many people, it's a bit Greek. It's just a little unusual for them. So, we need to do more fostering and more networking in that regard, but it's got a great bundle of resources, Mike.

There you go. And now all we need is another World Series and another Super Bowl and we’ll be fine, right?

Well, which do you think's coming first? I feel like they're both going to vie. It looks like they both get in the playoffs, we'll see, health willing.

Well, listen, Mike, it's a great place to end. Thank you so much for joining me. I really, really enjoyed it. It's great to catch up for sure.

And, as always, thank you to our listeners for tuning in. To our listeners who want to learn more about NewSpring, please visit NewSpringCapital.com.

Until next time, I'm Mike Mitchell, and this is Risk Playbook.