Dated but very insightful conversation with Irving Grousbeck, an adjunct professor of management at the Stanford GSB and the co-founder of Continental Cablevision. He discusses his experience as an operator, how the search fund model has evolved as an asset class and his advice to young CEOs. Some brief notes are included below – these are for personal reference only and have been edited/paraphrased (not a full transcript).

On his search criteria – he and his partner were both working in Boston post-MBA. They had been college friends. Started comparing notes and things they were uncovering separately. Then decided to work together. Put the word out through their network that they were looking for a company that was not too big, not too small, was profitable and had some growth potential. That was it for the criteria. Over the first 6-8 months, they looked at indoor tennis centers, bowling alleys, a plastic inflatable toy company and other light manufacturing businesses. From there, they started to refine the criteria a bit. They decided no product companies, due to the length of product development cycles, and the risk of obsolescence. Focused on service companies and were looking for recurring revenues, which was a somewhat new thought at the time. They also wanted a franchise business in the sense of having a claim on the customer.

On their near miss – the next to last business they came across was the then-nursing home business. Almost all nursing homes in the 1960s were in converted older, multi-story houses with circular staircases and all kinds of code violations, with people stacked all around these places. Then the Federal government passed the Hill Burton act offering long term loans at very low cost, slow repayment for construction of new nursing home facilities, recognizing there was a huge need. They got all excited about that because they were both MBA-types in their late 20s, looked at the numbers and saw all this attractive debt. Spent 2-3 months making up their business plans. Didn’t visit any nursing homes. Had this elegant business plan and then looked at each other and said I wonder if we should visit a nursing home. Visited 8-10 of them and, at the end of that process, realized this was not going to be any fun at all, it was actually depressing to look at these places. So they added to their criteria fun or at least a business they could engage in and was fun to be around.

On finally stumbling across the cable television business – Buffett says that when good management meets a bad industry, it is the industry that wins. The corollary of that is also true and was true in their case. They fell into a honey pot of a wonderful industry, which provided a cushion for feckless and totally inexperienced management. If there was a mistake that could be made, they made it. That is not false modesty – they really made a lot of mistakes in the beginning. They were well educated and halfway smart but just did stupid things.

On search funds trends – what surprises him is how much search funds have taken hold and a lot of that is pretty recent. Started in the 1980s with Kirk Riedinger and Jamie Turner, Jim Southern who had different versions of the start of searches. Added supplemental funding in one case and bought businesses that were successful, but not much happened in the 1980s. Search funds picked up some steam in the 1990s and then the dot com boom occurred in the late 90s and so that dampened everything down. But when 2000/01 came, the bottom fell out of that and that is when search funds really picked up steam. Just as he thought of the cable business as an interesting version of the real estate business (build an asset, leverage it, pay off the debt and own it free and clear), he thought of search funds as an opportunity for a few interested people to amass some capital and find a good opportunity and build a business. It was a path to entrepreneurship he had no sense would ever catch on the way it has in the last ~15 years or so. Variants are also starting to show up. Seeing institutional capital, purchase of secondary shares, longer holding periods, recaps etc. gradually starting to appear. Some signs of a maturing industry.

The future of search funds as an asset class – if you think about the ingredients, need opportunities, capital and talent. Opportunities have always been there, capital was always waiting on the sidelines, but the position was bring me a deal and I’ll consider investing it. Talent said I have no way to conduct a search – if I owe money from going to a good MBA school, I can’t look for a company part-time. The last mile was not constructed until the search fund idea took hold, that was last mile construction that brought the time to search, find a better quality company, and the attraction of the capital to have its risk capital stepped up and then have a low cost option on a better quality company. That attracted the searchers.

Looking ahead, an influx of capital is bound to continue and will probably accelerate. Institutional capital is either assembling or appearing. Opportunities are boundless. There are 100k+ companies with positive EBITDA just in the US. A lot of them not suited for search funds, but many of them are. What will happen is more and more talent will get attracted and the quality of that talent will diminish. There will be people who get funded who are not as good as the people who have been searching for and running companies. Parallel in a sense to the VC industry – it took off in the 1950s, gathered some steam in the 1960s, and became an industry by the 1970s. Then in the 1980/90s we saw groups of VC partners who could not raise subsequent funds because their investment record was not adequate. In this case, we will see searchers who don’t as a good job as those before have done, failure rates likely increase. Sad to say that, but it is a product of the pressures of capital. When there are returns of 30%+, it will attract capital, will have positive effects on the best searchers and deleterious effect on some investors and operators who are not as competent.

Common mistakes he sees young CEOs make – it is important to plant the flag for what kind of company you want even if you’re a first time CEO with no experience. Set down a few ground rules, make an opening statement. Have your people say he may be young looking and inexperienced, but at least he has some ideas about what kind of business he wants to build. The second thing he sees is this feeling that new CEOs have that they need to act like CEOs, which means putting on some kind of mask or affect and being someone that you’re not really. If a direct report comes to you and asks what do you think about this, you think you’re supposed to know the answer so you just blurt something out. He has done that countless times and it is dumb. The best answer is I don’t know, but let’s figure this out together. “I don’t know” is very powerful, shows authenticity and humility, and a desire to work with the someone and discover what the best answer is. Another subtle message here  – managerial effectiveness does not equate to knowledge of facts or what exactly to do situationally, rather that we can figure it out together. Encourages other people to open up and stop putting on masks as well.

Another mistake is losing sight of all of the people in your organization – the front line, middle line, your key team, your board. They are all people, find a way to connect with them as much as you can. Management by walking around is a favorite phrase, it was coined by Bill Hewlett of Hewlett Packard. Be human with the person and care about them, take an interest in them. You don’t have to spend all day, but walk around a little bit and get to know people in the organization.

Finally, it is really important not to lose sight of the things are really important, like your relationships with your family, friends, investing in yourself and in what you like to do, keeping yourself healthy etc. You’re going to have to sacrifice some things under the pressure of being a CEO but be sure it’s not the things that really matter to you the most.

Advice on hiring, retaining and firing – C companies hire behind the curve, B companies hire ahead of the curve, and A companies hire and fire ahead of the curve. The best companies make room for A players in key seats. There are B and C players in all great companies, but they aren’t anywhere near the top of those companies. So you want to be sure that you’re hiring ahead of the curve, but also thinking about who’s not promotable, who can’t ride with us two years from now when we expect to have grown 40%, what changes should we be making to make room for the right person in those seats?

On retaining people, remember that there are many ways of compensating your key employees, only a few of which have to do with money and stock. You can compensate them with authentic praise, with thanks, with access to information that they might not otherwise know that you do know, by seeking their advice etc. These are all legitimate ways of connecting with people. Remember, people don’t leave companies, they leave bosses. Be sure you are a boss they are not going to leave.

On having difficult conversations – directness with respect is one of his principles. Second, meet them where they are, which is an old phrase of the hospice movement. Think a little bit about where they’re coming from in the conversation. The last thing is that it’s really easy to write bullet points in advance of a difficult conversation and figure out what you’re going to say. But when you start to put them into words, it’s not always so easy. So you need to practice those difficult conversations. Hopefully with a partner or a spouse, or maybe in front of your phone and play it back or in front of a mirror. Practice makes it easier and makes you stumble less.

On culture and how CEOs can promulgate and nourish it – the culture starts and flows from you. And it’s from how you act, not what you say. If what you say and how you act are different, the only thing people look at is how you act. His simplistic way of thinking about culture is how do people talk to each other and how do people talk about each other. So how do we treat each other when we’re face to face and how do we talk about each other when the person is not present? So obviously respect is embedded in that statement. But you need to have a culture of productivity and collegiality and cooperation. One of his favorite phrases is you shine by making others look good. Now, to be clear, the world is also filled with sharp-edged, sharp elbow, tough companies that have been wildly successful. But it’s more fun to run a company the way he describes, and easier to attract and keep good people.