"Don't Even Bring Me the Deal" - The Red Flags That KILL an Investment

SPEAKER_1 (0:00)

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Christopher Zook (0:29)

We have a saying as a firm that we're freakish about alignment. So everything is about alignment.

We're the largest investor in everything that we do. We've got $750 million of our own money, invest in our own vehicles. So we always lead with our own money. That's alignment. Doesn't mean it's going to work, but it means we're aligned.

Patrick Bet-David (0:43)

But if we're not willing to bet our money, why should you bet your money?

Christopher Zook (0:46)

Exactly. But so what happened is the industry's continued to grow.

The ability to raise funds is highly dependent on how much of your own capital you're going to put in, which is typically 2 to 5 percent of whatever it is. So just use 5 percent because it makes the math easy. You raise a billion-dollar fund, you got to put up 50 million of your own money. That's great. You have good track record, you want to raise a 2 billion-dollar fund, now it's 100 million. You want to raise a 5 billion-dollar fund, that's 250 million dollars, and you haven't gotten your 50 back. So where are you going to get the money? That's why people will sell a stake to firms like ours because of the fact that they need growth capital to be able to reinvest in their business, be able to grow. And oh, by the way, when they raise that 5 billion-dollar fund, they're going to get 2 percent management fee on average, some higher, some lower, and they're going to get literally that billion dollars, okay, over a course of 5 years just from managing that portfolio, 5 years, I'll use 10 billion dollars, 10 billion dollars.

Patrick Bet-David (1:35)

10 billion is 5 years, 5 billion is 10 years.

Christopher Zook (1:38)

So 200 million dollars on a 10 billion dollar fund, do that for 5 years because it's locked up, it's contractual obligation, you're talking about a billion dollars. And oh, by the way, you take that 10 billion, you turn it into 20 billion, you get paid 20 percent of the profits, you make an extra 2 billion.

That's what the opportunity is to own a private asset management firm, whether it be a 500 million dollar firm, a 5 billion dollar firm, or a 10 billion dollar firm. That's why people will sell a stake, and if we buy, let's say, 13 percent of somebody's position, they still got 87 percent, we're very aligned. And that economic outcome is what makes owning a private asset management firm such an attractive business model. I mean, imagine this, you've got a lot of different businesses. Imagine if you had customers who are not allowed to fire you, and they have to give you a five-year contract. It's pretty easy to budget if you know your revenue for the next five years. And oh, by the way, if you have a billion-dollar fund, it takes you 20 people. If you raise a two-billion-dollar fund, it doesn't take you 40 people. It might take you another five or six. So you have this huge operating leverage. The average operating margin for private asset management firms, just for management fees, is 60 percent, profit margins.

Then on top of that, they get the carry. Then on top of that, they get the return on their money they put in their own fund, and they get the growth of the enterprise value, because if they grow from 3 billion to 30 billion, obviously, they're worth a lot more money.

And we now have over 100 different firms that we own stakes in that manage collectively 2.9 trillion dollars in assets, and have 12 billion of contractually obligated management fees over the next 10 years. They don't even ever have to raise another dollar, and they're going to make 12 billion dollars of revenue. That's the sustainability, which is not correlated.

Patrick Bet-David (3:14)

How hard is it to get into the business?

Christopher Zook (3:16)

Oh, it's very, very hard. It's extremely difficult.

Patrick Bet-David (3:18)

It's very difficult to create a PE firm and succeed.

Christopher Zook (3:21)

You got to have a great track record. You got to have people that believe in you, and then you got to live or perform.

Patrick Bet-David (3:24)

What's the... Okay, so if I talk about putting a winning team, I'm talking to Tom Penn. I asked him this question because he used to do the... Remember he used to do the collective bargaining agreements on ESPN. He was so good at it. I love when he does it. But if I want to put a winning team and I ask Shaq or the late Kobe or Magic, I say, what matters the most? The owner, the coach, the player, superstar, GM, what do they mean? And then they would all give their philosophy on what's the most important hire. On a P, if somebody wants to start a PE firm, what are the sequence? Five steps and what matters the most?