SMB Investing
Has anyone here thought about investing in or building a portfolio of small businesses? I’ve increasingly spoken to former finance professionals who’ve done this to varying levels of success, and it seems extremely interesting. You’d have to figure out the entrepreneurial side of it but it seems like an interesting thing to do after a few years in the industry. Capital allocation and scaling up is where you’d add value in my opinion. You might acquire your first business doing 1M EBITDA at 3x EV/EBITDA with maybe a 20% equity contribution and a low-interest-rate SBA loan. Operate that for a year or two while searching for a 2nd business to acquire while debt is significantly paid down/ Acquire that 2nd business. Now we’re at 2m EBITDA, 6m EV, 2m equity value. Maybe you did this after the IB - PE - B-school path and you’re 30-32 now making 2m? Now just buy small businesses as much as possible whenever an opportunity pops up. Make operations more efficient with scale.
obviously not as easy as it sounds. Market is red hot right now and I’m sure the two key issues are 1) finding businesses to acquire, as I know search funds often try for years and fail and 2) actually managing and running the business day to day as you have near to no operational skill set and are working with different kinds of people than you’re likely used to professionally.
I'm looking into doing this now. One thing I've learned is that multiples for quality SMB's with $1 million EBITDA+ (decent economic moat, strong reoccuring revenues) are not 3x. It's more likely 4-5x, yes even in today's interest rate environment (1Q23)
You might be able to get a bigger seller note than 10% with prime so high, but don't believe everything you read in the books and on SMB twitter. 3x for $1 million EBITDA is not really out there for a first-time buyer with no operating experience - at least not in any major metro. Maybe if you get out into the countryside, owners might be a bit more aggressive on their multiples, but I'm actively searching now for niche manufacturing businesses with $750k-$1.5M EBITDA and sellers thoughts are generally in the 4-5x range.
Can I ask how you think about sourcing these? I know it’s competitive intelligence but honestly I’m 5+ years away from thinking about something like this, but I really would like to do this at some point.
My plan is to continue the PE track because I love the job and then do something like this on the side. I would rather do SMBs but I have enough transaction and PE experience to know that it will be anything but easy. So then CRE is the other option, but less interesting of course and would be a different world than I’m used to.
I digress - even just the sources you read on SMB acquisition / personal investment strategy would be extremely appreciated if you don’t want to share your personal knowledge base, which I would totally understand. Also happy to PM, really appreciate you! Would love to hear how you are thinking about the sourcing, execution and then how involved you expect to be in the operations too (do you have a VCP?).
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