Search funds: "like shooting fish in a barrel" (from ex-F100 CEO)
I was at dinner with one of the recent history great CEOs (F100 for 20 years roughly ~2000 - 2020). I asked him what he would do if he was my age and he said probably search funds. He described it as shooting fish in a barrel, talking about how they are just so many small businesses with older owner operators transitioning out that you can get at phenomenal prices.
I know there is an element of truth and I know he's still "doing stuff" so isn't just talking out of his ass. That said, I see so many of my former MBA classmates just totally failing at search funds. I haven't looked under the hood, but IIRC the stats aren't awesome on search fund results.
Is this because of a selection bias, e.g., the really great investors are going to HF/PE and search funds are "unemployment insurance" for people who don't otherwise get great jobs? I don't know how to square this up in my mind. It peaks my interest because I have classic PE experience plus operating experience so can't help but wonder if he's right, as I am pretty sure I could raise about $75mm of equity for a search, and I'm realizing that careers in general are much harder in your 30s when you are "flying the plane" than in your 20s when you are "jumping through hoops" in inning 1.
Any thoughts?
I keep hearing about this boomer-retirement wave. I'm in Tim Dillion's camp on this one, these boomers are hearty and will not relinquish control of any of their possessions including their homes and businesses.
$75mm is a huge search fund/single co. and more like a micro cap fund..
I tend to be in the same camp which was one of the reasons I am scratching my head. I hear stories about small business operators basically saying "I cannot begin to tell you how many HBS/GSB grads I get calls from asking to buy my business 'to preserve my legacy'".
Sidenote if you do raise a fund - hit me up.
Yea... as soon as I saw that $75 mm figure I thought this entire post is off.
That's an insane amount of money to entrust to some fresh MBA grad. They are only getting that if they come from an UHNW family, with family et. al. contributing well over 50% of that.
Maybe it is high, I don't know. But FWIW I am not a fresh MBA grad so not pulling that number out of my ass based on MBA comps.
Definitely sounds like a UHNW family. I don't see any reply from OP denying it. Know a few people like this from my MBA program who have families worth multiples of $75m and even for them, I doubt it would be easy to raise that type of money (outside of family) even with their family legacy. Most searches from my understanding via MBA are around ~$15-20m at the high end.
such a bad low iq boomer take lmao
search fund space is COMPLETLEY played out. theres like hundreds of them forming each year as every MBA program has somehow tricked inumerable students they are ready to be a "CEO" after taking some easy MBA biz and leadership classes.
I know someone who owns a gravel company sub 10mm EBITDA. He says he gets like 20 emails a week from MBA newly graduated students asking to buy his business and operate it. NONE of them have any industrial hands on experience (most have never probably done hard labor in their life). Says its out of control how many kids are trying to buy his business.
And its a total scam for the "CEOs". If you look at the normal transaction structures for these you have no control, very little voting power, and are basically a pawn for a bunch of self righteous investors who demand updates and control everything you do. I watched one of those search fund panels once run by the typical LPs in the space (sorenson, anacapa partners) and it honestly sounded worse than being a PE VP knowing I would be basically answering to these guys and have no control.
You are not a CEO, you are basically a PE VP who is doing operator work 24/7 vs being on the investment team. Comp is lower too.
not to mention the whole search fund space is super cringy. everyone has the same website for their fund, the same stupid name (SenecaTrails Investment Partners). I cannot imagine how annoying it would be to find myself working 20 years at a 8mm EBITDA pipe fitting business only to realize my new boss is a 28 year old kid from Greenwich who has never done hard labor in his life.
That's fair. I wonder about the operational part, if these guys had had a few years working in one of those businesses as opposed to being newly minted grads often without even investment experience in the area they're targeting. I think about this from the personal lens of being a guy who has operated P&L enough in my sector that perhaps there is some relatability that has washed off what I have heard called "the Goldman ick" (not really about Goldman but any finance background), such that the investing experience is attractive insofar as it is analytically rigorous when combined with a few years of the operating experience to give credibility that you know what it takes to do that which you identify is attractive to do.
There's a curve, right, where a certain mix of operating and investing experience (0 of one and all of the other at one end, and flipped at the other, with every permutation given a number of years work experience) makes you more credible to these owner operators. I wonder if through that lens there's a heat map for each permutation grid, given every number of years of work experience, where search funds either does or does not become attractive. The flip side would be that, for a given number of years of experience, perhaps as search funds become attractive, your alternatives become even more attractive, so at no point (or a materially small number of points) is it the optimal outcome.
Getting a little bit philosophical but do you follow my thinking?
any of these inbound MBA search fund wannabe calls ever mention an interesting / enticing price? or are they always heavily weighted on some earn out structure which is inherently unattractive since its some no experience 28 year old MBA?
Agreed. The math really only works out for the searcher if (i) it's a bigger deal (at least $3mm of EBITDA), but then you're likely competing with private equity, and (ii) you can generate much better than 2x MOIC.
On smaller deals, you're competing with so much dumb money who are able to somewhat easily finance their deal with SBA debt.
Good take.
Not to mention many of these businesses are doing well precisely because they don’t have massive amounts of acquisition financing on their balance sheets.
What do these funds expect? That adding a lot of debt to a gravel company will somehow make it more profitable or operate better? They expect the CEOs to make more gravel? Magically boost the demand for gravel? Or somehow make better gravel?
The business is an honest, local, nuts and bolts business and it works just fine without stupid financing on top of it.
This thought occurs to me often. Why does every gym, food franchise, grocery store, industrials company in the US need to be acquired and 'optimized'. Sure things are worth more on paper but I feel like it standardizes everything and businesses lose their edge, and in consumer facing businesses all of their personal feel for the sake of profit for investors.
I'm wondering what goes through the head of some of these willing sellers who cave to search funds.
I always assumed it was something along the lines of "Aw yes, got my bag, so long suckers!"
This is very much a 10,000 foot, corporate guy view with a dash of Dunning Kruger. A few things that are skewing his perception from the realities on the ground:
Just some thoughts off the top of my head, will add some more if they come to me.
Could give please give some color on the participating preferred structures / general transaction structures that these LPs who demand board seats typically like?
It’s a participating pref structure with a 7% PIK preferred interest rate (possibly more nowadays - I ran a traditional search a couple of years ago).
If you’re raising search money, the terms are always the same. The investors effectively have standardized term sheets. You raise search money, and if you find a company, that will step-up 1.5x and convert to a pref. Then your acquisition financing is also in pref form. Searcher is awarded with 25% of the equity if all goes well (1/3 immediately vested, 1/3 time vest based on 4 years of operating, and 1/3 performance vest on a sliding scale from 20-35% IRR).
Example: raise $500k in search financing. Find a company after 2 years and require $10M equity financing.
- $500k steps up to $750k pref
- $10M is also a pref
- So, $10.5M total pref, which will now clip at a 7% PIK
- On exit you need to pay back the $10.5M pref along with the 7% preferred interest, then split the remaining equity pari passu according to terms outlined above (hopefully you get 25% of this, but it will be time and performance dependent).
APAE
I’ll chime in. I’ve done this once under the very onerous terms (board involvement, industrial grind, white shoe MF investors attempting to run a comparatively very small manufacturing business, equity out of the money etc.) alluded to above.
On one hand, it might be the best practical business experience I can think of. There is no hiding behind a boss, a team, or anything else.
It’s all you baby. And you will have big wins and big fuck ups.
I am buying a second company. This time all me. No LP’s with no experience in the space this time around.
Most of my success in getting this next higher quality company comes from my blood sweat and tears from the first one. I’m not a random white shoe newly minted MBA off the street. But you can only get to that point by going through the first fire (buying and operating a business as a virgin operator).
As stated above, most of these super low LMM/SME type businesses are pretty much just jobs for a new owner. Run em out and wind em down. They don’t fit the profile to buy at any meaningful price.
A trend I noticed several years ago is newly minted MBA’s or former mid career private equity guys jumping in the SF/ETA/fundless sponsor model hoping to immediately hire an operator and then spend their days in the nirvana of board land and golf courses. That’s a pretty sure sign to me that they will fail. You aren’t buying a $10m business and then sitting on your hands on easy street. Everyone wants to be Brent Beshore Buffet and build their own mini baby Berkshire.
On the topic of legacy owner incoming from brokers and MBA grads. It’s very true.
Hell, I received 20 messages a week immediately after buying my business on my first go around.
How were the economics for you in the first transaction?
I heard market is just getting a bit too saturated. Too many guys are starting funds. Pre 2010 was free money though
Macro timing is probably the most important factor
You'll have a high probability of creating a $10m+ liquidity event for yourself in a short time
Most who have done it from my experience, have caught a bull market and have done well for themselves. Probably the best thing you can do for yourself career-wise in the space
It's a very dumb take IMO.
Running a smaller company fucking sucks and is 100x harder than something doing ~$100m+ in revenue.
It is the exact opposite skill set of what people in high finance have.
I have run tons of companies with 8 figures in revenue BTW, and I have not met very many good "hired gun" CEOs because they do not really exist for that size of co...lol
Agree - I'm hesitant when a former head of whatever at a $B+ public company think they can start over or run a roll up strategy without the infrastructure they were used to.
This is so true. And people from "high finance" often cannot fathom how unmotivated and, for a lack of better word, lazy many people can be. You think because you have an "analytical mindset" and have jumped through the hoops of the corporate world that you are able to apply some of the PE playbook to companies that are somehow underdeveloped, but fail to realise that most of the time you'll just be running around putting out fires because every stakeholder around you needs handholding and needs to be pushed. It's a really tough job, and by no means an easy way to make a living.
In addition to all the competition from other searchers trying to find similar businesses to you, you still need to pass investment committee. There are opportunities for searchers but they will take far more creativity and execution ability to realize than most have and are situated for via their capital sources.
The funds and institutions backing search funders are all looking for healthy cash flowing businesses with easily identifiable MOATs at discounts. If you can even find this type of company, good luck applying enough leverage to make your IRR work in this environment.
There is far more opportunity that lies in “turning around” small, dislocated tech companies. The work you have to do involves not just fixing the cap table and operations but doing actual product and engineering work. You are buying a business that sort of works with an existing customer base and building a better mouse trap.
There are a couple firms who are doing this and at least one is executing this strategy superbly but not through a search fund model.
Who is doing this? I had a different conversation with the founder of one of the really great infrastructure / enterprise VCs. He basically said the same thing: buy subscale software businesses that used to be 80% growers with an 80% grower cost base, but are now 30% growers with an 80% grower cost base, and do the million of low hanging fruit right-sizing initiatives. This actually is what I did back in my investing days a long time ago but not at subscale businesses that a larger platform wouldn't want to acquire, but rather at $50-$100mm ARR businesses for hairy-ish companies (e.g., not 90%+ GDR retention types).
Say more.
Firms aside, Pipe is an example that immediately comes to mind
Search funds tend to attract the worst types of people from MBA programs. Want the prestige of working in private equity, the financial upside of a building a startup/SMB, and the "high level" work / ability to boss people around of a CEO, without doing any of the real work required to achieve those things in the first place.
Funny yet scary accurate.
I apologize for resurrecting this, I am responding to 'mentions'.
Doing the classic search fund model is not a particularly attractive path today.
The major search LPs have all coalesced around standardized terms that (surprise) grant them all the upside. As a searcher you are basically agreeing to a parlay bet that combines a high-probability / moderate-payoff leg with a low-probability / good-payoff leg. Note that neither leg of this ticket is a 'great' outcome.
Today you don't see the vaunted sucess stories that existed two decades ago where someone delivered 15x on equity and got written about in GSB cases or papers. Private equity as an asset class has matured such that lower middle market firms are out chasing these same assets. Sellers have, in some ways, gotten more sophisticated where they aren't going to LOI with the first (or twentieth) person that calls them to offer money. Business owners have more or less all learned what SEO is.
That doesn't mean that you shouldn't search for an asset though.
You can do an unfunded search.
If you don't require people to put up $500k to give you (and maybe a partner) 24 months of runway to find a target, and if you're capable of getting a target under LOI and doing diligence to compile an investor-ready data room without handholding from the search LP team, this is a really attractive path.
At this point, you're really an independent sponsor. There is a broad capital audience available to you.
If you are serious that you could raise $75m of equity, and you're willing to stomach the uncertainty of this path and the potential for embarassment (not knowing all the answers all the time, being told 'no' more than you ever thought possible, having someone walk back on their word after you made a representation to someone else, I could go on...), I agree with your CEO friend that this is an awesome risk-weighted path.
Your bet is now low-probability / obscene-payoff. Personally, I take those every day of the week. That's been my entire career, actually.
All you focus on now is changing the probability any way you can.
The anonymous "VP in IB - Gen" dogging search funds is right to say that there are dozens being formed every year. The counterpoint is that they're all being made by middlish people. The real differentiator common to search fund people is initiative and risk tolerance: not intelligence or aptitude. If you're smarter, proactive, and have an iron stomach, you will very likely excel.
You can also excel by looking for a different type of target than the classic search fund target. Everyone looks for a 'so simple a caveman could do it' opportunity. Those are hard to come by. You won't find many 'pipe fitting' companies or aerospace widget manufacturers or SMB software companies with $2m EBITDA laying around.
If you have experience working at a fund that is thesis-driven and you've done research around a particular space, you already know how many interesting assets are under-resourced or mispositioned. Pursue those. It will take longer to get done, but it is almost always more worthwhile.
One interesting path that just came to mind is partnering with this CEO. Ask him if you can use his name and rolodex in exchange for doing all the work. If he has the 'halo' reputation you say he does, any seller would probably respond favorably to a small or new firm he is involved with reaching out to them. I'm sure there are also several companies or business units he is already aware of that he could rattle off half a dozen real value creation levers for.
If you could get him involved, that would boost the amount of capital you could raise and I'm sure that (with effort) you could assemble the capital structure to close on an asset of the likely size one he'd be aware of would be.
I did one of these during the pandemic. I partnered with two other young guys. One of them successfully convinced a former public CEO (niche industry, high-growth stock) to be the face of the entity. We hired a bank who raised us $150m. The target we eventually closed on required more capital; they ended up getting us over $350m of equity.
Basically:
Wonderful write up, glad you made your way around to answering those mentions!
APAE covered most of it. A few quick points I haven't seen mentioned, or wanted to mention succinctly:
In order to do it today and be successful, you need to have high risk tolerance, like the field, be very optimistic naturally, and likely have partners or get lucky with employees to make the experience fun and not a disaster. Have invested in several of these and the ones that have done well are the ones where there's usually more than a single person and the searchers aren't HBS types, they are state school to goldman to middling PE firm types. It's hard to really take over a company if you aren't rooted in a working class background and most the people that seem to want to run these funds are people that are extremely detached from the people they anticipate managing. It isn't going to go over well if you talk to a 20 year manual labor worker about your HBS trip to Ecuador lol.
Of those you invested in, have you noticed a particular sector that usually performs well?
Yeah, I'd call them services to software plays, but honestly for awhile rollups did great. They both are different flavors of the same thing imo.
Both were really going at getting multiple expansion. Services to software you find some company that isn't sophisticated and through add-ons gradually position as more of a software business. You then ride off the software multiple even though the business isn't really a software business. Think like some tech services where you can create a software platform on top of your services provided and try to claim recurring revenue even though it's "reocurring" and at its core the business isn't much different than like a barber or frequent handyman with a scheduling tool.
The rollups are just straight up getting enough critical mass of companies that the business could be bought by PE rather than being some sketchy off Market deal where you have to deal with a family owned business without records. HVACs were all the rage for awhile, vets, dentists, etc.
Again, all benefitted because you could have bought anything at call it 4x revenue decade ago and then sold it for 8x revenue recently. Really was just an exceptional run for trying to start a business or flip a company. Now it's a mine field of people thinking they are clever getting in too late and getting clobbered.
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