Buyers and Builders
00:33:40 · Greg Geronemus
The idea of working without any income, incurring deal expenses for one, two years. That's just... That's a nice idea for many, but it's not... It's often not on the table. But for those who have savings, it can... And they have an interest in a particular... Maybe they wanna go for something really small, maybe more a lifestyle business where they have... One of the benefits or features is that you can own a greater percentage of the company, sometimes up to 60 to 80% of the company. Whereas in traditional search, you're often owning more in the 25 to 30% range. There's also a perception of... I think this is maybe more perception than reality. The opportunity for greater autonomy in self funded search. You don't have a board. It doesn't feel like you have anybody to answer to. Self funded search has often become a vehicle for people who have a hard geographic constraint. So, you know, if somebody is... They're living in Milwaukee, Wisconsin, their family's rooted there, they wanna go find a business to buy, and they can't move. They're not gonna move, but they wanna be an ETA entrepreneur. They're not raising a traditional search. Traditional search investors, Footbridge, others will not back a Milwaukee focused traditional search. The odds of acquiring a business, especially one of sufficient scale, are just too low to be backable. But could somebody find a very small business that they could SBA finance and raise a little bit of outside equity? Sure. So that can be a good reason to go self funded. Where I think you have in this sort of self funded versus traditional search debate, where I think you have people get it sort of incorrect or wrong is there's a belief that in self funded search by virtue of the larger ownership percentage that there's greater economic upside. And I think that that is simply a fallacy. That's just not correct. People conflate ownership percentage with dollars that you can earn, And there's just so much more nuance to that. It is... Yes. It's a larger percentage of the pie, but it's a much smaller pie. So that's that's one. Two, there are significant and really difficult implications of being in a really small business. You have less cash flow to reinvest. It's much harder to attract and retain talent. It's much harder for an operator to extricate themselves from the day to day of a business.
00:36:37 · Greg Geronemus, Mikk
Because you a small business, a small team. If you have five people on your team and one person sick, that's a 25... 2020% of your workforce is out, and that's a bit of a crisis. So it's harder to take a step back and think strategically. You also don't have... Often don't have the benefit of a board to coach you and mentor you during difficult times. And I... I've got a much longer list than there... Than that, but I always encourage when people are thinking about self funded versus traditional search, whether they have the capital and is stashed away and the ability to do self funded search or not, just think about and do the math. Because if your motivation is around economic upside, there's more nuance than you might think on the surface. [00:37:33] S0: I found a... I'm quoting you in here what you've said previously on one of the podcast and again, you, traditional search is a win win for both investors and entrepreneurs. I think this sums up. Let's sum up this part.
00:37:33 · Mikk, Greg Geronemus
[00:37:33] S0: I found a... I'm quoting you in here what you've said previously on one of the podcast and again, you, traditional search is a win win for both investors and entrepreneurs. I think this sums up. Let's sum up this part. [00:37:49] S1: Yeah. I mean, look, I think, you know, there are a lot of advocates of self funded search describe or create this construct where traditional search is this sort of predatory concept... Predatory model where investors are taking too much of the equity or... And not giving enough equity to traditional searchers. I I think that the data speaks for itself that that's not true. There are people who... The many people who have made, in some cases, tremendous fortune, and in a lot of cases, a small fortune on traditional search as entrepreneurs. There's a lot of rest that traditional search investors are taking and a lot of work that they put in to support search entrepreneurs. And they're deserving of the rewards that they get. And certainly traditional search entrepreneurs are deserving of the rewards that they get. And I think the model has been around for many years. I think it's beyond fair and I really do believe it's a win win. There's plenty of upside to go around. [00:39:08] S0: We covered one side. We covered the self funded search side when it comes to the ownership, which could be like 60 to 80% of the business. But can you elaborate the ownership structure for traditional search?
00:39:08 · Mikk, Greg Geronemus
[00:39:08] S0: We covered one side. We covered the self funded search side when it comes to the ownership, which could be like 60 to 80% of the business. But can you elaborate the ownership structure for traditional search? [00:39:22] S1: So it's 25 to 30% depending on whether it's a solo searcher or a partner search. And it's broken down into tranches that vest for different reasons. So let's just go with a partner search for a second where you can get up to 30% of the economic upside. A third of that 10% vests at close as a reward for closing the transaction. 10% vests over time, typically a four year time vest. And then the remaining 10% vests subject to performance IRR hurdles. You begin to invest into that... The the third tranche at a 20% net IRR, and you max out on that third tranche through a... With a 35 net or higher internal rate of return. [00:40:22] S0: Okay. And now the last topic, the rise of committed capital vehicles and holdcos. Over the last two years, we've seen an explosion of committed capital vehicles and permanent holdcos. What do you believe is driving that trend? [00:40:39] S1: Let me take a step back and just explain how the... What the model is and how it how it differs from traditional search, and then I'll I'll get into sort of [00:40:46] S0: the Okay.
00:40:46 · Greg Geronemus
[00:40:46] S1: The drivers as I see them. So I'll lump I'll lump committed capital vehicles and holdcos together because I think they're more similarities than differences. But instead of in a traditional search where, as I mentioned earlier, searchers will raise search capital, giving them two, two and a half years of window to hunt for a business to buy. Committed capital vehicle holdco entrepreneurs will approach investors, typically the same investors where we participate equally and happily in both traditional search and committed capital vehicles. So entrepreneurs will approach us and say, I wanna raise $15.20, $25,000,000 to go out and buy... For the most part, do a consolidation of buy and build in a specific industry. So it could be a specific subspecialty of health care or a vertical within software. You know, could be... You know, you you name it. It it runs runs the gamut across across industries. And so, you know, unlike traditional search where a searcher might have a few ideas for the industries that they're gonna go after, This is a hyper focused entrepreneur or entrepreneurs. More often than not, it's it's a a team. Sometimes you'll see... You're... More and more, you're seeing three three person teams as well. So they'll they'll they'll get commitments from a group of investors to fund whether it's 15 or 20 or 25,000,000 to go after that strategy. It is referred to as a committed capital vehicle, but there's some nuance there around the committed piece. Investors have... There will typically be two or three investors that are on the board of that committed capital vehicle. And those investor board members need to approve any deal that's done or any capital that's called. So there's still, you know, a healthy governance dynamic, and it's it's certainly not the case that a searcher or entrepreneur can just call capital whenever they want to pursue anything. So in some ways, it's committed, but there are... There's governance and accountability embedded in the model as well. But fundamentally, these are for people that that wanna do a a roll up or consolidation play. That that is the strategy. So inorganic growth has to be a significant driver and component of the thesis.
00:43:39 · Greg Geronemus
I would say over the last six, nine, twelve months, we've seen a massive shift from people who would otherwise pursue traditional search, now moving into this committed capital vehicle holdco model. Nine months ago, I thought it was maybe just a, you know, a small adjustment. Now I'm convinced that committed capital vehicles are gonna take significant traditional search in the years to come, and that's that's happening real time. You asked what's driving that trend. I think there there are many things. One, there's... It's definitely an element that it's the new shiny object. So I think people... It... It's the it's the hot, sexy, exciting thing you do. So I I don't wanna I don't wanna I don't wanna overstate that too much, but I also don't wanna downplay it. You know, it's it's more elusive and and exclusive than than traditional search. The bar for the entrepreneur is higher, so the people who are able... Who self select in or are encouraged to go down that path, I think just feel special because they're doing something that not the entire ETA ecosystem would be able to pull off. So I think that's one. Two, there have been increased data points... Increasing number of data points in the... Over the last several years that inorganic growth can be a buy and build. Zero acquisition strategies can be significant drivers of outsized returns in the lower little... Lower middle market private equity investing. So there's a... This is a... In part a response to that trend. Three, you see... You know, part of this, I think, is a response to the increased difficulty in for searchers to acquire businesses. So if you have a if you have a traditional search where typically you're buying just one business and there isn't much of an understanding around buying additional businesses after that, you feel the pressure to go and buy a bigger business. So you wanna buy something 2.5, three, 3.5, 4 plus million of EBITDA. If you have a committed capital vehicle where you know that you're gonna be buying businesses, many businesses over a three to four year period, you feel more empowered and comfortable going further down market and maybe starting with a business that has $809,100,000 dollars of EBITDA that gets you in the game. It's not a you'd wrong to call it a platform, but it gets you it gets you in the action. And once you... And you can build EBITDA from there.