Refining your focus

My decision to solely target B2B software businesses

When I planned to launch my search fund, I reviewed dozens of searchers’ websites, most tying back to the same three categories (or some flavor): business services, healthcare, and software. Within each of these categories, searchers appeared to be going after the same niche markets due to their respective tailwinds and the investment style of the search fund community. To keep my opportunity set broad and conform to those who have successfully raised search funds and acquired businesses, I did the same by initially focusing on those three broad categories.

In the first four months of my search, I dove into two particular niches with entirely different business models, one services-focused and one software, and what I found was somewhat surprising. In conversations with business owners, I sometimes struggled to articulate what I was looking for. Yes, I had a set of criteria, but they varied a bit based on the business model. Was I valuing the business on recurring revenue, EBITDA, or some combination of both? How should I be thinking about the quality of their revenues or their cost structure in general? I knew I needed to make a change to have more fruitful owner conversations.

After reflecting more on my first quarter lessons, I recognized that I could more effectively qualify opportunities and articulate my thesis with business owners by refining my focus exclusively on B2B software. I could double down to better understand the business model, communicate effectively with owners on what we’re looking for, and differentiate myself from others in a convoluted market. Further, its attractive business model provides the opportunity for equally high-quality revenue streams with increased scalability relative to services-based businesses. I won’t dive into the specifics of the SaaS business model but instead explain my logic on how reeling in my criteria helped certain aspects of my search.

Concentrated knowledge

As a searcher, I find that coming up with new industries to research is one of the most challenging activities, more than having owner calls or doing any analysis on a particular space or business. I recognize that some searchers struggle with other areas much more, but for me, this element of the search has been a real pain point. Refining my focus to purely B2B software freed up some of that concern by giving me more clarity on how I should spend my time when I am not meeting with owners. By only looking at this business model, my industry research focuses more on the core products that a particular solution provides and the end markets they serve. Further, I’ve been able to leverage countless resources online on vertical SaaS and broader software investing by some of the leading venture capital firms and thought leaders in the space to sharpen my perspective. Although I still have a ways to go, the tighter focus has taught me the importance of getting to the core of how a software business creates value and whether the solution has a sustainable competitive advantage.

Easier communication

While the effectiveness and personalization of our outreach play a large role in determining responsiveness, none of that matters if you fumble the ball in the initial owner calls. The first impression is crucial for searchers to land, and having clarity on what you’re looking for can provide you with the confidence needed to develop trust in the initial call. As I began targeting software businesses exclusively, I refined my marketing materials to reflect that focus, which helped qualify leads before that first call. Before the change, my one-pager that I’d share with business owners highlighted my desire to target businesses with over $10 million in annual revenue and $2 million in EBITDA, although I considered software businesses with $3 million in annual recurring revenue (ARR) and positive EBITDA following the Rule of 40. Just imagine the confidence I destroyed in my initial calls by walking through some IF-THEN statement explaining why I am open to looking at businesses outside of my STATED criteria. It took me a while to get there, but removing that conditionality from my search relieved an unnecessary burden that has since allowed me to better understand what the business does and laser in on the investment thesis's key bets earlier.

Differentiator

I don’t need to tell anyone that buying a high-quality software business at a fair price is challenging, especially with the best ones having a rich opportunity set of exit options from lower-middle market private equity, strategic competitors, family offices, other searchers, and sometimes venture capital. It is no secret that these businesses are attractive, and founders know that. If I were a founder looking to exit, I’d immediately disqualify anyone who was not solely focused on software. In fact, many founders ask questions about exactly that in our initial conversations, and my refined focus has helped articulate my commitment while separating myself from other buyers. I can then focus on why I believe White Cedar (i.e., me and my investors) could make the best fit, given our combination of experiences and networks. 

The downside

Narrowing your focus comes with many benefits, but it is not without risks. Making this decision was a bit nerve-wracking initially because I’ve significantly shrunken the pond I am fishing in. The quantity of software businesses within our criteria is a small fraction of services-based businesses in the U.S., there’s no other way to put it. As I’ve looked at numerous software deals up until now, certain elements of these smaller software businesses make me skeptical as a potential operator. What level of customer concentration am I willing to consider, and can I structure around that risk? Is there enough upside in its addressable market to grow this business? On another front, am I searching for solutions that don’t quite exist yet in certain verticals? Whatever the issue may be, the thought that there is a clear reason why the business hasn’t been picked up by other (likely larger) buyers is always a concern. While every business has flaws, they feel magnified as a searcher when you consider buying it on an ARR multiple and want to capture all three tranches of your equity. In some cases, financial leverage will not be utilized in these transactions, which presents even more of a challenge for us searchers to ensure we have some margin of safety. We need to be confident that a company’s recent growth is sticky and will continue for the foreseeable future.

While there’s no way to mitigate these risks fully, I’ve gained some comfort in trusting my systems and processes to guide me to the right opportunity. I know that if I keep that faith and continue to do the right work, good things will come to our team. Yes, there’s no guarantee that this approach will directly result in me buying a business, but I am confident that it beats the old approach. Isn’t that half the battle of searching anyways— consistent improvement?

For searchers just getting started, I hope you can learn from some of these early mistakes to help you drill into exactly what it is you are looking for and build the processes that enable you to go after it.