The appeal to LMM PE in Canada
Many of us have done a LMM “Private Equity” internship at a small PE working for a group of entrepreneurs typically buying and holding industrials manufacturing companies. We did this because we got to put PE on our resume for recruitment. Looking back at it, many have left banking to start a LMM PE shop with their friends and have done very well; let alone the guys from non traditional backgrounds entering. It seems like there is limited barrier to entry to starting a shop, buying mom and pop cash cow LMM enterprises and growing them to produce stable cash flows.
Has anyone else seen the appeal in this? It seems like many people are doing this and tend to have a niche interest in industrials/manufacturing, possibly because their 3 financials are easier to understand.
What are your thoughts?
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Barrier to entry is the capital. Once you have that you play the origination game and capitalize on boomers retiring with kids that have no interest in the family business
Pay at LMM private equity in toronto is low (associate 1 ranges from 150-185k all in based on some interviews I had).
I ultimately ended up going to work in the private equity arm of a pension (pay is much more). Ping me if you want more details.
Just curious, what firms are paying that? $200k+ is what I've been quoted
There are over 400 search funds in Toronto alone. The vast majority of them do not perform well, and we’re much more likely to see the successful ones than the failed ones.
Curious where the 400 number is from. On assumption it is true, do you not also think that there could be 400 businesses of some success to transact on in Ontario alone? I’m not sure this is a reason to not look at LMM PE from the standpoint of a principal position. Particularly given how few buyside seats and upward mobility exist in Toronto
Bunch of the search funds I know ended up acquiring in the US. The economics of that model are really tough, even more so in this environment. There's just not enough depth in Ontario.
On the flip side, there's a lot of opportunity in the Prairies and some on the east coast. Boring old world industrial or businesses that spit out cash flow but not at scale to attract institutional capital. They don't really work for the search fund model, but I know people who bagged cheques from rich AB dudes and are operators now. I think that model makes wayyy more sense. Same as the search fund process, just without those economics.
LMM in Canada is small relative to south of the border. Also raising capital in Canada is a pain in the ass, especially institutional capital for LMM. The risk tolerance is just much lower, which is annoying af.
It works if you can find a family office or someone wealthy to write the cheque. There are a lot of LMM opportunities but they're hard to find outside of networks. There's a good universe that's a tier above business brokers and too small for even the smaller boutiques. Incredibly hard to find unless you're local and plugged in, but they are there.
I believe holdco's can sometimes make sense in the Canadian landscape if that's what you're referring to, but if you're referring to search funds (looking to acquire a single asset) then I don't see the appeal.
It's shocking to me how popular Canadian search funds have become when:
1. There aren't any SBA-equivalent loans available to its citizens; and
2. The country has fewer sizeable businesses relative to its US counterparts (even when adjusting for population).
These are important considerations given the structure of search fund deals. Canadian searchers will lose majority equity to their investors (i.e., the searcher is typically awarded 20-30% of the common, returns-dependent). Also note that investors typically come in via a pref, creating an additional hurdle beyond the debt for the searcher to clear before clipping any proceeds.
What this means is, for a Canadian searcher to have an attractive economic outcome for him/herself, the target should be:
1. Very large; and/or
2. Growing rapidly.
Now consider how PE and PE-backed co's are increasingly transacting further and further down market. As we know, relative to search funds, PE funds are more sophisticated, have a higher probability to close, and have a lower cost of capital (e.g., 20% vs 35%). Therefore, it's very unlikely for a searcher to acquire a large, growing, high-quality asset. This takes target #1 cited above out of the picture almost entirely. So, what they're left competing for are deals that are unattractive to PE, which to me implies they're likely in a poor industry or are sub-scale. Ignoring the former case for obvious reasons, a sub-scale target can still look good to investors (they're ok with cutting a small check since they're likely backing many searchers), but to the searcher you better hope the target scales exponentially, otherwise you're left with a lackluster economic outcome for yourself.
You can begin to see why the model makes more sense in the US: there are larger and more assets available, and the SBA allows you to retain majority equity, meaning even if you transact on a sub-scale business that doesn't grow exponentially you can still have a fantastic personal outcome.
To those that refer to the silver wave, "there are so many boomers retiring and will need a successor" - you're right. Many of these businesses will become or are already available. However, whether these businesses are searcher-appropriate is an entirely different consideration. Most of these businesses are either extremely sub-scale (e.g., <$1M EBITDA), are owner-operator dependent (to the point where the owner-operator essentially is the business), or play in unattractive industries. All to say, of the wild figure often cited regarding boomer businesses for sale, the number of them truly transactable is materially lower.
Of course there have been some success stories, but to the question of whether anyone sees the appeal - I personally don't. :)
Very good post and completely agreed. I think where acquiring a small business becomes interesting is when you do it a bit later in your career than most search funders and have the ability to self-fund to some extent or at least, to be able to raise funding outside of the typical search fund model. I have been looking at opportunities with some operators in my network for a few years and there's a lot of chalenges in finding attractive opportunities. As mentioned in the post above, you're not getting anywhere near any kind of fast growing opportunities and I do agree that you end up competing for deals that are unattractive to PE. Furthermore, my experience with boomer businesses is that either the owner is so integral that retaining them for a decent transition period is a must (and a huge risk) or the owner have already professionalized management and is stuck in a situation where they will never be able to generate the same kind of income they get out of the company today with the proceeds from the sales and therefore, cannot "afford" to sell.
Now, a $1M EBITDA business in a niche market that is unlikely to grow above inflation may not be attractive as a PE play with outside investors where you need strong returns to make it worthwhile to the principal, but paying 4-5x to buy personally such as business as a cash flow play is a different story. Although we don't have SBAs in Canada, there's a lot of programs that alongside seller financing, can allow you to buy these businesses with 80%+ financing and provide really attractive returns.
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