Episode 03 | Part Two: Investing During a Global Pandemic

Gregory Shepard, an entrepreneur who's built and sold 12 businesses, a recipient of 4 private equity awards, TEDx speaker, and Forbes author. This is The Boss Podcast with Gregory Shepard.

Welcome back to the second part of my interview with Peter Mallouk from Creative Planning. He's a financial rock star and has been named the top-ranked independent financial advisor in America by Barron's for 3 In part 1, we talked about how your investors reacted to COVID-19. Peter, how long do you think this will affect M&A activity?

Well, I think, you know, it depends. To me, it depends how long this goes. So if, if we have a treatment that improves the mortality rate by a factor of 10 come out tomorrow, everyone's gonna go back to being crazy. I mean, I think we're just gonna go— it'll be really fast, V-shaped recovery across the board, dancing in the streets, you know, Bars will be packed and M&A will be on fire. If this takes 3, 4 more quarters, I think we're gonna see what I would call a great, kind of a great economic cleansing. You know, real steep recessions, they create real winners and losers.

Yeah, sure.

And I mean, businesses go under that were hanging on, some businesses that maybe could have made it go under, the strong get stronger. I mean, that's what happens. in steep recessions. And so you have all these players that came in with all this dry powder buying, but you have a lot of people that are going to be able to just be trying to keep what they have afloat. You know, there are some may be overleveraged, some of the business models may not be playing out as expected. And I think you're going to see a lot of small business failures if this goes on 3, 4 quarters. And I think when that happens, Those that are bigger or stronger, or that happen to capitalize at the right time and are just lucky, are gonna be able to take advantage of that. The real—

Fire sale acquisitions, basically.

That's right. To me, it's all about, I mean, you can be great, but if you got fully invested 9 months ago, and an idiot just got fully invested today, the idiot may outperform you. So part of it is, who's got the dry powder on hand, and who's leveraged or overleveraged, and what businesses do you own? But the biggest factor here is gonna be how long does this go? Right now, most people can get through, for all we're hearing, most of us can get through this, most businesses can get through this. You tack on half a year from here, I think we start to see some real suffering with small businesses that will really work its way through PE. And I think impact valuations for a decade to come. Because when you look at how— when a PE firm comes in and buys an entity, they like to have their baseline scenario, and that baseline scenario had always been generally favorable. There's over 8,000 private equity funds now. This is a phenomenon of the last 10 years. There wasn't even private equity until the '80s.

Sand Hill Road wasn't even there.

Yeah. You've got most of these funds have never seen a bear market. They've never seen a worst-case scenario play out. And now what they're going to consider a baseline or a worst case is going to be totally different than it was before.

So can small businesses go up when the market's bad? And can the market go up when small businesses are closing? Are these things attached?

They are attached, but they are attached based on a timeline. You know, this is not my analogy. I've heard this. I'm— I like it a lot, which is The economy and the market are like a guy walking a dog in a park. The dog and the guy are going to get to the same place, but the dog is running around his legs and trying to chase a ball and sees a Frisbee go by, he is moving around all over, and they do not match up perfectly. I think if we get a V-shaped recovery, which means to get that, everyone has to feel safe going about their business. That means you have got herd immunity somehow, whether it is a vaccine, or we get there the hard way, or there is treatment. Then the market and the economy go up together.

Okay.

If this goes on 2, 3 years, the economy's gonna tank, small business tank, 53% of employment's from small businesses, you have record unemployment, those people aren't gonna spend as much money at McDonald's, Chipotle, Costco, Walmart, the stock market's gonna tank.

Yeah, I see.

There's an in-between though, where the market can win and Main Street can lose. And this would be super unfortunate. And that's where this is a— doesn't become a depression, So we don't recover quickly. It's a very deep, long recession. A lot of small businesses go under, unemployment goes up, but it makes the bigger companies stronger as people move to do business with those bigger companies. They're using Netflix more instead of going to the small movie theater chain, for example. They're going to the big restaurant chain instead of the local restaurant. What is the market made up of? The market's made up of the big companies. So if you have this scenario where small businesses go under, but not en masse, and but that business moves to the bigger companies, you're going to create more division between Main Street and Wall Street and the rich and the poor. I think that would be because the rich are the ones that own stocks. You know, most Americans don't own— they might own a little bit, but most aren't participating there. And so I think that would be, to me, the worst-case scenario for America is that outcome.

So let me— there's 2 questions I have. The first one, and they're not attached, but you brought up something that I want to dig into a little bit, but The first thing is, how does all of this affect the startup ecosystem? So I work with a lot of startups and I work with the accelerators and the incubators and the VCs and the PEs and angels and all that stuff. And every— all the startup people are thinking, what is this going to do? Is this a bad time to start a business? What if I'm 50% through my business and I'm getting ready to do another round? Like, what would your advice be for entrepreneurs that are at either ideation or past proof of concept and into maybe their Series C round or A round? Like, what would you say? Hold back, roll in, coil up, and just weather the storm? Or are you saying, what would be your advice for them?

So as you know, Greg, the main reason that these businesses go under is they're undercapitalized, right? So it's always capitalization, leadership, time, idea, and capitalization is a big part of it. And a lot of my clients, this is what they do. They build businesses, they sell them, they build businesses, they sell them. But when you're starting, you have to raise money. And the reality of it is that's exceptionally hard to do now. So, we always have a list of clients that are interested in looking at ideas as they come about. Most of them are like, hey, I'm just not interested right now. I want to wait and see how this settles down. I have a friend who can never do more than one thing in a day. Like if you go, hey, can we— you want to go get the dogs, go to the park? He'd go, oh, I'm going to the dentist. Well, are you going to the dentist from 8 to 5? You can't also go to the park?

Yeah.

It's the same thing here. A lot of people just look at this and go, look, my brain is occupied and the world doesn't seem stable. I'm not interested in the idea. Even if I've got $5 million and this person's raising $50,000, I love the idea. I just don't have an appetite to see ideas now. I think we're seeing a major contraction of the willingness to do capital investment right now. So I think that hurdle is gonna be hard for people to overcome.

I see the same thing as the investors are just sort of coiling back and saying, okay, hang on. We got to see how this plays out a little bit more before we take any risks, even though the valuations are dropping.

It's the irony of all this. People want to invest when it's going to cost a lot more, and now they can get a bigger share of the company for a smaller price, but they're paralyzed. And this is the conundrum of the investor. It's just how it plays out.

That's the other part of the question, right? The other part of the question from an entrepreneur's perspective, now from an investor's perspective. So, you know, I look at businesses, I look at probably, I don't know, 100, 200 deals a month, right? And I look at these deals and I'm seeing valuations dropping substantially, you know, a $10 million company dropping down like $5 million, you know, for a round. And the investors are like, hold on. And I'm like, this thing's like 50% off. It's like on sale right now.

Yeah.

When would you not want to buy the same company on sale? So what advice would you have for investors? I mean, should they be looking at these? I mean, I understand what you're saying in terms of their behavior, but is that behavior logical considering, you know, your perspective, which is unique, right? Because you're seeing things from a 50,000-foot view.

Yeah, I think, I mean, your point is great. I, I look at it 2 ways. So first, I always start with the individual. So the individual needs to just do a reality check. Okay, based on how I was invested before, where my money is, how my money is now, what my needs are, do I have enough money to meet my needs this year, 5 years from now, 10 years from now, 20 years from now? We need to check that box.

Yeah.

Let's assume the answer is yes, that this person's invested wisely, made good decisions, has a plan in place, and is secure. Okay, we'll set that aside. Then yes, they should be looking at deals now more than ever. But just because a business is 50% off doesn't mean it's a bargain. Usually there's a reason, and I think the existential risk for that business is probably greater, right? They, they may have been double 2 months ago, but they may have had a 50% chance of success, they may be half price today with a 10% chance of success.

Yeah.

So I think you still have to look at that business through the lens of, we've got a macro issue and then you've got the micro issue. Yeah, we have to evaluate the business, which is the micro component, like, are these the right people? Can they get this pulled off? Is this a good idea? But then we have, even if all of that happens, if no one can go outside and no one's gonna buy anything, will this work? You still have to evaluate that deal through maybe an additional lens than you would have a few months ago. But if you've got the time and you've got the money, and you're personally secure, there are so many deals that you kind of have the pick of the litter now to find one that makes sense for you.

Let me ask you this. So, I tell people, I say, you know, it's like a fortress. I call it a fortress of solitude, right? Once you have your fortress of solitude with a moat around it, then you can risk a little bit of the money that's sitting outside of the fortress of solitude, right?

I like that. I'm gonna start using that.

Yeah. So, when you have that fortress of solitude, now you have, you're like, okay, I'm good. You know, for the rest of my life and my children are fine, everything's fine. And now I got this bundle of money I can play with. When I look at, you know, private investing, I look at 2 types of businesses, basically an opportunity-type business. This is a business that makes money. And a problem-type business. This is a business that saves money. So I think of a bear market as businesses that save other businesses money versus, you know, a bull market, which is businesses that make money. And So, what I've been telling entrepreneurs, if you have a business that is— and I would like your advice on this— so, if you have a business that is actually selling itself as an opportunity make money type business, change your narrative so that it looks more like a business that is saving money. Is that good advice? That's what I've been telling people.

I actually think that's brilliant advice. You know, one of the offerings we have at Creative Planning is we handle 401s and it's a very low-cost way of doing it. It's booming right now because it's being sold for as what it is, a way to, hey, we can improve your situation and save you money while you're going through this. People are very receptive to that right now. So I think that advice you're giving those small businesses is a great, a great angle. Thank God.

When you look at like 9/11 and 2008, so I survived these things, right? I was building businesses at that time. And I survived these crises, but this thing is different. I mean, very different. Can you tell people how this is different from those crises? And how— is there any way to predict an outcome based on the differentiation between 2008, which is a real estate bubble, even the tech bubble, uh, you know, and then 9/11, which was a temporary shift in fear? You know what I mean? Can you give us some advice on what people could—

Yeah.

You know, what do you think is gonna happen? I mean, just from Obviously, you're the most knowledgeable person I've talked to about this. So what would be your prediction, if you will, on what's going to happen in the next 5 years, even if it's scenario-based, like if-then-based?

Sure. Well, I would start by saying all of those events that you mentioned, they do have a commonality. I mean, these were all very, very, very steep bear markets. I mean, typically, bear markets are a 34% drop. All of these were in the '40s and '50s. And what they shared in common was fear and uncertainty. I mean, a lot of fear and a lot of uncertainty. You know, we look back at 9/11 as a solitary event now, but really back then it wasn't. We, we thought it might happen again and again and again. I mean, every day there was, we caught this person here and they brought that ring there. This truck was in Times Square. I mean, We went years and years. I remember watching it every night just to make sure from an investment perspective, I knew what was going on. We did not know when it was gonna end. It turns out it was a singular event, but it took us a few years to figure that out. With '08, '09, you know, we look back at it now as if, oh, you know, it was horrible and we got through it. At the time, we were actually wondering if the economic system itself was going to work or was it gonna completely collapse? Was the banking system gonna collapse? If it collapsed, the market would have gone down 95%. I mean, it would have just been completely game over.

Yeah.

So we have that same fear and uncertainty now. I mean, we, you know, if we get that treatment or that vaccine in the coming months, we'll all look back on it and go, it was horrible, we were in whatever, but we all knew we were going to get better. We don't really know that, right? We don't know what the outcome is going to be here. There is a worst-case scenario here that is not a 1% probability. You know, it's a 20% or 30% probability. And that scenario is We went into quarantine when COVID-19 was out there. We're coming out of quarantine, and there's probably 200x more COVID-19 out there than there was when we went into quarantine.

Yeah.

Nothing has changed, right? There's way more of the coronavirus out and about today than there was when we went into quarantine. If we look at all of the models, it's going to get worse every day. And the question is, how much worse is it going to get? There is a narrative where it continues to get worse, through the summer and it becomes unbearable in the fall. And we don't have a treatment that greatly improves the mortality rate. And we don't have a vaccine that comes this year. And we go back into quarantine. And this time that restaurant doesn't stay open any longer. That small business can't make its loan payments and the hotel chains and the airlines can't make it. This is a super depressing scenario and it's not a crazy scenario. And it's the reason that small stocks are down 30% and large stocks are still down 15, 16%, and parts of the market are down 50, 60%. We also have a scenario where we go back out there, maybe summer makes social distancing a little easier, and maybe some of these treatments really do improve the mortality rate. Maybe the vaccine comes at the end of the year. Maybe the kids go back to school, but there's some social distancing, and next year everybody's back to normal. Also extremely reasonable scenario, and the market would be at all-time highs in no time. We have that uncertainty, and that uncertainty creates is what's creating the fear. I think the market's priced right where it's supposed to be. I think it's perfectly rational today. I think it was rational after 9/11. I think it was rational after '08, '09. And, you know, I'm hopeful that we're going to go back out there, that the reality is more people are going to get this, more people are going to die. Hopefully people that are most at risk are really smart and do things to protect themselves, like my parents who are just flat out staying at home all the time. And that hopefully one way or another we get through this in the coming months and we get that V-shaped recovery. I'm rooting for that, but I have no confidence that that's what's gonna happen.

I've been talking to some people and they say there's a scenario where the thing just goes rampant and everybody ends up getting it and a certain number of people just die and that's just how it ends up going down. Is there, I mean, do you think that that's a realistic scenario? I mean—

Well, I think that's, to me, that's the first scenario I laid out. And I think that's a very realistic, I think we're gonna go back out there, the coronavirus is out there, it's going to spread, people are going to get it. I think that's a very, very realistic scenario. We hope for a reprieve from summer and things like that, but, you know, my scenario number one is it continues to spread until we get to herd immunity, if that's even possible, you know, if you don't get it again and so on without a— so of course that's a real scenario.

Yeah.

And this is where health and economics differ. Let's say for a moment that you have a true horrific health scenario, which is All of that unfolds in 100 days, the market could actually recover from something like that, right? Because now we've got it in the rearview mirror, we can move on. If that's something that unfolds over 15 months, well, nobody's doing anything through all of that, right?

Mm-hmm.

And so then all the businesses collapse. And so we are very much tethered to the healthcare story, as we should be, but there comes a point where we can have economic recovery despite Bad things happening.

Okay. So I want to talk about something really positive. So Ernst Young made you Entrepreneur of the Year in your entrepreneur days, right?

Yeah.

And so with that in mind and all of the entrepreneurs that are out there, you know, wishing they could be you, what advice would you give them right now? Is there anything you could say, look, buckle up, this, that, something like that that they could go with in closing to the podcast?

I mean, my best advice for somebody who wants to be an entrepreneur or just successful in business is find somebody that you could learn from and do whatever it takes to be around that person. Intern at their place, work for them for, if you have to, for less than you would work somewhere else, volunteer for things to be around that person. I mean, so much of what I learned was from observing others. We now live in a culture too where you don't need a formal mentor that's gonna go to lunch with you every week. You can follow them online and learn from them on Twitter, LinkedIn, Facebook, or following their blog or whatever. That real-world, how does this person do things, you just cannot beat that. It's going to beat any book, any college degree. There are so many things like your podcast that people can listen to where they can get more information than they could get in a semester of college. Look, I'm an advocate. I just tweeted yesterday, everyone should go to college. You can't beat learning from somebody who's doing it or has done it.

Thank you so much, Peter. I mean, you know, I really, really appreciate it. Everybody's going to really appreciate this podcast. Peter is the President and Chief Investment Officer of Creative Planning. Thank you so much. It's very, very appreciated.

I loved it, Greg. It was a blast. Thanks for checking out The Boss Podcast with Gregory Shepard. Get more on Greg's Business Operating Support System, BOSS, at GregoryShepard.com. This has been a production of Forbes Books Radio.