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.
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 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.
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).
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