OnSearching
@on_searching
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Documenting the real-time ups and downs of a self-funded search. #SMB #ETA #SearchFunds #HoldCos
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Joined September 2023
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Reached out to the owner of an interesting commercial services company - size and geography seemed right. Turns out it's owned by an HBS searcher who just sold the company to PE. He gave me some words of encouragement to keep going...
...and that this is his fourth ETA exit
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New proprietary deal:
- Revenue: $3M
- EBITDA margins: 12% ($360k)
- Asking Price: $5.5M (15x)
The seller is a smart, nice guy and acknowledged his industry is in slow decline and that the growth prospects are not great. I hope he gets his number, just won't be from me.
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I have a bad feeling there will be a wave of bad outcomes for SBA acquirers over the next few years - that could mean both BKs and weak returns. I hate to write that, but multiple new searchers have told me they lob LOI's at every biz they can at 4x, without caring what it does.
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When I spoke to searchers before I got started, one consistent piece of advice I got was to keep my new deal pipeline going even if I get under LOI. I figured that would be a given and incredibly easy. Turns out, it's insanely difficult in practice both mentally and practically.
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Met with a serial acquirer utilizing solely SBIC debt to avoid signing PG's. Avg EBITDA of deals is ~$3M. Rates are high (at least 15% today), and they usually take equity too.
Any other searchers seeking this out? Feels like a one-stop shop if you can land with the right fund.
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It's one thing to talk about LBO'ing a small company via an SBA loan with a PG but it's another to actually do it. Choose people to work with who understand that risk and embody it as if it was their own. Many looking for a fee but couldn't care less your life's on the line.
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Search and PE is about sales and likability. Everyone echoes the same things when they raise money and meet sellers about their values, how they treat employees and what they're great at. It's all about who can source the deal and get that family/owner to like and trust them.
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@moseskagan
I don't think the people choosing the entrepreneurial path (and succeed at it) are necessarily the same people who succeed at the PE/HF path. HF/PE is coloring inside the lines and constantly getting the "right" answers on a charted path vs. navigating with no map & hustling.
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I know I shouldn't be shocked at this point, but I am consistently blown away by the laziness, sloppiness and lack of intelligence of small business brokers. I'm reminded daily that if these guys were truly great they'd be middle market investment bankers. Sad truth
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Getting a text from a seller asking how you're doing after a broken LOI feels like getting a "you up?" text from an ex at 2am.
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Call with a seller and of course it started the moment when my daughter decided to throw a fit. Rather than derail the conversation it actually moved things in a positive direction given he's got 3 kids of his own and could relate. Teaching her to cry on my zoom call from now on
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It's easy to get discouraged during a search but it's important to remember it just takes one deal to get in the game. Patience is the key and the search process itself weeds out most.
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Having a deal under LOI die after several months of work is the ultimate kick in the nuts. Better to avoid the trauma and carnage of a bad deal, but still not fun.
Onto the next.
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Have heard many times that working capital issues can make or break deals and I am feeling this in real time as I deal with weak books/inventory tracking and cash-based accounting. Getting a true feel for COGS/margin and understanding normalized inventory level is brutally hard
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Even though I'm under LOI on a deal, I have meetings with two new proprietary sellers today.
The odds of closing are slim, and the worst spot to be in if the deal died would be with an empty pipeline. Plus, a little extra leverage to push the seller under contract never hurts.
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Looking at smaller deals definitely makes you change your frame of mind. Things go from working "on" the business to very much "in" it. Problem with a customer? You're going out there. Inventory needs to be moved in the yard? That's on you. Different, more humble, entry point.
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I've been revisiting this thought and draw comparison to housing in 2007-2009. It's plausible we'll look back from a 30,000 foot view years from now and realize how crazy it was for people to be LBOing highly risky SMBs with government-backed debt and zero industry experience.
I have a bad feeling there will be a wave of bad outcomes for SBA acquirers over the next few years - that could mean both BKs and weak returns. I hate to write that, but multiple new searchers have told me they lob LOI's at every biz they can at 4x, without caring what it does.
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Nothing screams proprietary SMB seller more than said seller telling you their $500k EBITDA business is worth 20x. I'm sorry to inform you pal but your 15-person business does not warrant the same P/E ratio as American Express 😂
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Whoever said proprietary lead generation is a waste of time couldn't have been more wrong. Life-changing opportunities are just an email away!
P.S. - there were no typos 🤷♂️
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Dealing with a seller who is truly ready and willing to sell is the most important seller characteristic other than trustworthiness. Every single conversation is exponentially more difficult when the seller's heart is half in the deal.
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Over a month after signing an LOI, the seller has now said he's willing to part with his real estate in addition to his company. That makes the deal much easier and sweeter for me. Only problem is his valuation is ~2x market and wants more for the property than the biz 😂
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One of the best things a searcher can read
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The amount of institutional capital and HoldCos dipping into SMB buying seems to be growing exponentially, making a difficult path for individual searchers even harder. I've found my one advantage has been to be authentic - the right seller will want YOU just as you want them.
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Proprietary deals are truly a blessing and a curse on the polar ends of both spectrums
Uncontested shot on goal, but no professional guidance or sense of urgency from the seller. Glad I don't have competition, but wish I had an unbiased third party to talk some sense to them
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When you receive the seller's balance sheet and... wait for it... it doesn't balance.
This is SMB acquisition
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Have gotten into a regular cadence of meeting the seller at his local pizza shop 2x a month to get docs & talk in person. Even though we speak almost daily (and I'd prefer he use DropBox) this has been a nice way to keep things moving. Tough convos are easier over pizza & soda.
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If your seller does a post on LinkedIn announcing the birth of his granddaughter get him an LOI immediately
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Spray and pray in and of itself is not the problem (though I think it's not great to waste people's time). It's the fact that people read about search and fail to separate the 25% unlevered yields from what it takes to actually run these businesses to generate those yields.
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The ideal seller has the title "owner" or or "president" on LinkedIn, no picture, 0 connections
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I am at the stage of my search where I'm posting in local facebook groups
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Best earnout structures for SMB buyout? Most obvious structure seems to tie payouts to revenue performance but I've thought about something income-related as well. Seller staying on for 1 year.
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Mixing the sourcing up - spending time getting in front of local accountants and lawyers, specifically those focused on corporate, M&A and trusts. Putting their clients aside, these are people who are well-connected in the local business community. We'll see if it's fruitful
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Have spoken to several tech people looking to get into cash flowing businesses.
The VC "factory" model is broken. With IPOs not happening or pricing well it's trickling down to every stage. Those who got on the VC treadmill are looking to have optionality in capital structure.
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Wife: What did you get me for Valentine's Day?
Me: The promise of future shared liability in a personally-guaranteed SBA7a acquisition loan.
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This is now the second time during my search that a proprietary deal I passed on came to market through a broker and found its way to me via email alert. I like seeing where the numbers landed compared to seller projections. Both (of course) way below the seller's expectations
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One of the toughest elements of the search phase is the stagnant nature of the search itself compared to other jobs where progress is measurable. Despite the learning and progress towards a deal, it's a binary outcome - you buy a business or you don't. Easy to see how people fold
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Furniture distribution business... Expected EBITDA margins? What's a fair purchase multiple? ($2M-$3M EBITDA)
Looking for ballpark ranges to frame up a meeting w/ seller today and confirm my initial thought process.
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These are qualified searchers w/ great resumes.
Small businesses often exist bc the founder had a skill, slowly hired a team around it, built relationships & created a durable biz over many years. This isn't just investing. It's people and problems. I worry most don't see that.
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One funny bit about negotiating a proprietary LOI. Every time I said "typically" or "traditionally" the seller would get mad. He doesn't care about what Buy Then Build or the HBS book says. There are no rules and this market is a blank canvas - get the facts, but get creative.
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If you're a self-funded searcher willing to relocate, DM me. Might have an opportunity for you.
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There is definitely a middle ground to be had between the free-wheeling, handshake deal mentality that so many SMB owners have and the overly-analytical and incredibly detailed/methodical way many MBA searcher types (like myself) tend to be.
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@BigJohn043
Learned this one the hard way. As a solo searcher, it's hard not to fall in love without a partner to gut-check you and call out your rosy assumptions. Well said
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Ok... here's a fun one. Setting a working capital peg when the seller uses cash basis accounting (doesn't show inventory on the books)
@Slackwatercap
@SMBFinancingGuy
@sbabmarks
@guessworkinvest
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Anecdote: pool construction company for high-end pools is down 75% (Northeast-based)
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One unique way to find leads for local searchers - find towns/areas you want to acquire in and research who's sponsoring little league teams (it's usually published on some township website).
Tedious but fruitful and your intro email is practically written for you.
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Small business brokers: "We are as professional as investment bankers on Wall Street"
Small business broker's headshot on their website:
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Some days just suck. You get excited about a deal, prepare to go under LOI, when all of a sudden the seller decides he wants over 10x EBITDA for his business based on some bad advice
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I think a lot about businesses that employ 1099 models (like roofing, painting) where the employees should clearly be in the W2 bucket.
Wondering if this will come to an end and if there will be more risk in buying a company that relies on 1099 compared to a firm that W2s
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@sohaventures
Biggest under the radar star that is not PE-backed is Gunner Roofing. Those guys built a $100M biz from nothing
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I always think about the competitive landscape on deals I'm pursuing
Today I went back and listened to an old
@InvestLikeBest
podcast with
@willahmed
. I love how little he thought about competition
SMB is not building custom hardware & tech, but it's a great mentality nonetheless
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Coming from a career where progress & success were measurable, search is the opposite. Putting aside the operating results, it’s a binary task (you acquire a business or you don’t) that could take years. Days & weeks are like running on a treadmill without the feeling of “wins”
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Self-funded searchers - thoughts/advice on structuring a forgivable seller note? Idea is to have it tied to current revenue to ensure business does not dip below. Roughly 15% of purchase price.
@Slackwatercap
@FetaFund
@yetanothrsearch
@bonapartay
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Where are people seeing SBA7a loans these days? Prime +~150-175 feel right?
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@HockJohannes
Agree with all of this. 8 months in, it's been frustrating and at times laughably difficult. Good brokers pedaling bad deals. Sellers more aware of search or at least the concept of it. Rates making debt more expensive and driving down the multiple you can pay. etc etc etc...
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For geographic searches, I'd think about what it is that the markets you're in do really well and what they don't do well. Easier to jump into an industry that is favorable locally than one with headwinds. I've been surprised by the regional discrepancies of similar businesses.
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I'm brainstorming how I can market myself differently as a searcher to source unique opportunities. Have any searchers explored abandoning the cold email outbound (in my experience, low hit-rate) in favor of things like SEO/paid digital marketing?
Brokered deals have been 👎
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Best NYC-based search fund investors/firms? This can include lower middle market funds
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Most well-respected traditional search fund investors in my book: Will Thorndike, followed closely by Jim Edmunds and Kent Weaver. Who else am I missing?
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Random HVAC anecdote. Had my unit serviced yesterday - the tech was 22 years old and instead of going to trade school, he applied directly for a job as a tech at a local company. They offered to train him on the job. Unit is fixed but I was definitely wondering how good he'd be.
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The temptation to start a business in an industry I'm looking at buying into becomes incredibly enticing during a challenging negotiation.
I know it's the very antithesis of "buy then build", but in a world where everyone is buying assets, I often think it could be time to build
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@Slackwatercap
@sbabmarks
I wasn't able to get it. For a combination of reasons, I feel ok (not great) about it:
1) ~3x multiple, incl. WC
2) leasing property from seller
3) GM & key employees staying on are friends of his; legacy matters
4) have close connections who have done biz w/ seller for 40 yrs
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How do the "permanent capital" HoldCo's like
@chenholdco
and
@PermanentEquity
think about investor terms? Obviously, without the intention of selling those businesses in 5-7 years, it changes the economics of those deals dramatically.
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Now I want to buy a deck company just to say "I built the back deck at Club Aqua"
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@amandaorson
I'd say those labor costs are pretty low but this is directionally accurate. Risk lies in project-based revenues (limited recurring opportunities) and incredibly low barriers to entry (everyone from landscapers to GC's getting into fence).
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@guessworkinvest
@blueprintsmb22
@Slackwatercap
@SMBFinancingGuy
@sbabmarks
Getting handed a bunch of old inventory (vs. the new stuff he bought "extra" of this year to sell) is exactly what worries me.
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@LisaGForrest
Easier said than done Lisa! Love the structure but seller's don't love it as much
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Being a geographic searcher is frowned upon by the search fund mafia... and I get it. You're narrowing your deal flow dramatically. But there are advantages to the strategy:
- local knowledge
- credibility with sellers
- ability to be "in" the market at networking events
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@yetanothrsearch
Helpful context for me as I'm working through diligence on a deal I feel I am slightly (but not majorly) overpaying for
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Deal aspect I don't often hear buyers discussing is rent. On a deal I am working through, the seller materially underpaid rent to himself. Now he will be making up for lost time, charging me ~double (appropriate market rent).
A severe hamstring on the business in addition to debt
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@ShowMeYourCIM
@SMB_Attorney
@MillionairesPod
40-50% are fraudulent, hmm... but you know what helps? A QofE...
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Straight from the mouth of a seller (proprietary opportunity): "I barely show up. This business runs without me and is a cash cow. Customers keep coming back and we barely have to compete. You will have to physically push me aside to take this business from me."
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Who are the best long-horizon SMB funds and holding companies? (I understand they're different structures but have similar mentality & goals).
In my eyes,
@chenholdco
and
@PermanentEquity
represent the gold standard, but there are so many out there. Any others? Family offices?
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@codywagee
@Chris_Schuering
Good way to put it, though the aspects of control and more amortization on the financing front make it attractive! I know you know that better than most
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Loved this
@60Minutes
segment as I have thought a lot about how I'd properly incentivize employees post-acquisition. KKR has seemingly nailed the "do good and do well" aspects of allocating shares to employees. KKR's returns show proof is in the pudding
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Having a sounding board of friends who know you and understand SMB deals is essential and I will probably tweet this dozens of times during my search. A personal Board of Directors is key.
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@OneManLBO
Leverage and delegation are two pillars of the same idea in my book. Operational leverage depends on the ability to delegate successfully and that's a skill in itself
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@OneManLBO
Being rigid on those characteristics is classic form of those who search for 2+ years and never close a deal. Over time, have to figure out where you're comfortable being flexible with risk. I can say I've loosened my requirements in certain areas as my search has progressed
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@ShowMeYourCIM
Clearly not a shot at you guys (I think you obviously understand that).
And to be fair, I do understand the broker's POV. They work for the seller, and they hold the keys to the pot of gold we as buyers want. Just airing a gripe
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Anyone have stats/study citing the % of deals with seller financing?
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@ShowMeYourCIM
Hey... that's not to say there aren't diamonds in the rough. I love when younger, hungrier, more professional people get into this space - have met some recently. But broadly speaking... you have to agree!
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Every search fund website looks the exact same... and frankly I think most sellers don't give a shit about your "integrity" and "mission-driven" principles.
They just want their number and an easy process.
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Has anyone seen an instance when, under LOI, the seller's accountant refused to share the Quickbooks?
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@FetaFund
@someguyzburner
@Slackwatercap
@yetanothrsearch
@bonapartay
Does anyone have an example they'd be willing to share? Can obviously redact deal-specific info.
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