Prioritizing good economic characteristics
Identifying growing industries and businesses with common characteristics will prepare you for success as a search fund entrepreneur.
“When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact.” – Warren Buffett.
This Warren Buffett quote sets the stage for a typical school of thought in the ETA community on the impact that industries, businesses, and entrepreneurs have in creating value. The underlying idea is that industries and business models are more predictive of success than management teams, especially first-time search CEOs.
I’ve seen this referred to in various ETA resources, and the concept of the race track (industry), horse (business), jockey (entrepreneur), and trainer (investors) has helped further this idea of how entrepreneurs can think about setting themselves up for success. I will use a slightly different analogy with Formula One (F1) racing instead of horse racing, which I hope will be more intuitive.
While there are competing views on which elements are most important in the broad context of entrepreneurship (many argue the driver is most important), the industry and business are foundational for a budding entrepreneur in ETA.
Finding a race track (industry) with excellent conditions
Think of each race track as its own industry. There are some race tracks that everyone wants to be on, and there are others that drivers do everything in their power to avoid. It is no different with industries. As F1 teams do not want to drive on tracks with poor weather, bumpy roads, and no barriers to protect drivers and their cars, search fund entrepreneurs should not seek industries with deteriorating fundamentals.
We will think of industries through the lens of both financial and operational dynamics. Identifying industries appropriate in a search fund context that meet these criteria will be challenging, so it is essential to acknowledge that no industry will meet all of them. Below is a list of common economic characteristics in industries appropriate for search fund acquisitions.
These elements are common in ETA and are meant to minimize the risk of operating a business as a new CEO. First-time CEOs and their investors can then focus on building the best racecar (business) as possible with the wind at their backs rather than trying to do so in an unfavorable environment. That being said, searchers and investors have varying views on industry criteria – it is highly subjective to their risk profile, experience, and general opinions.
Optimizing your racecar (business)
Racecars represent the businesses in a given industry. As an entrepreneur, you as the driver have the opportunity to buy an existing racecar that is structurally sound and will perform to help you win the race. Because searchers are buying an existing racecar and not building a new one from scratch, there are several characteristics one might look out for to make sure one is not buying a lemon.
Like industries, we will consider both the financial and operational dynamics important when evaluating an individual business. Again, these are meant to minimize the risk and uncertainty of operating a business as a new entrepreneur, but more importantly, to ensure that the business itself is healthy, competitive, and has clear growth opportunities. Below is a similar list of common economic characteristics appropriate for evaluating business models in a search fund context.
Every search fund entrepreneur will have individual revenue, cash flow, and valuation requirements, and these vary widely depending on the model they pursue. I’d say the most typical search fund criteria range from $5 million to $30 million in revenue and $1 million to $5 million in EBITDA. For self-funded searches, these ranges are typically lower, and for partnered or sponsored searches, they can go much higher.
Simply put, these businesses must be competitive. There must also be a solid foundation within the business so the searcher is set up for success, meaning that there must be solid middle management and the opportunity to improve practices within the firm.
Building the right team (investors)
The racing team represents the team around you as a searcher, particularly your investors. Depending on your personal and professional objectives, investors can help you find the right tracks, build and maintain your racecar, and grow into an elite racecar driver (or CEO). Some entrepreneurs prefer to be the lone wolf while others prefer much more structure – no one choice is right or wrong.
As ETA evolves and more capital moves into the ecosystem, it is essential to recognize that not all money is equal. Investors add varying levels of value to searchers besides capital, including warm introductions, operational expertise, resources to support your search, general mentorship and guidance, and governance support. By finding the right group that aligns with your objectives and challenges your thinking, you can minimize some of the risks associated with pursuing ETA as a career path.
Lean into your strengths as a driver (entrepreneur)
At the end of the day, you are the driver and responsible for racing the car. Operating a fundamentally strong business in a growing industry will only get you so far. We as entrepreneurs must properly allocate resources within the firm, manage risk, inspire others, and treat our employees, customers, and other stakeholders with respect.
But first, we must buy the business. There’s an overwhelming pressure to close a deal during the search phase, so it is reasonable to deal with thoughts of compromise with a business that isn’t right for you. However, this is a long-term decision that will impact you and your loved ones for many years, and it should not be taken lightly. It is important to recognize that the entrepreneur keeps the acquisition in mind in the context of their greater lives. Finding the right match is just as important as anything else. What good is it to lead an organization where you will be miserable day in and day out? That is not fair for you, nor is it for the company.
Given the intensity of operating a business, I recommend that you lean into your strengths when considering industries and business opportunities, as these can be a source of light for you in determining fit. Consider your professional experience, personal interests, family background, and investors’ expertise in finding the right business. How can this opportunity enable you to maximize your potential and seek help from others when needed?
A final word
We discussed the importance of buying fundamentally strong businesses in growing industries and their characteristics. Then we shifted our focus to the topic of people, from investors to the entrepreneur. We tend to discount the importance of entrepreneurial fit and the team around them. We can do all of the analysis we want on a given industry or business, but if you are around people you do not see eye to eye with or simply do not like, what is the point? An entrepreneur cannot realize a business to its full potential if they are disengaged, plain and simple. So as much as these economic elements are crucial to your success, focus on relationships - with your investors and with yourself.
Please subscribe to stay in the loop on future Maverick posts if you've enjoyed this article. We will be back with a deeper look into the traditional search fund model in two weeks, where I will share my experience raising a fund and why I chose the path.