Matt Gilbert
June 17, 2022
This is an Excerpt of an article from Yale School of Management that we found interesting.
YALE CASE MAY 2, 2022
Completing a search fund transaction involves many challenges. On top of raising capital, identifying a high-quality asset with appealing economic characteristics, and ensuring the business is for sale, an aspiring entrepreneur must also convince the budding seller that they are the right buyer for the business (after all, desirable businesses often have many potential suitors).
To accomplish this, the search fund entrepreneur must detect the seller’s top priorities in a transaction and prove that they can fulfill those goals. A deep understanding of what sellers are looking for can help potential buyers offer sellers exactly what they want to proceed toward a mutually rewarding transaction efficiently (or move on if buyer and seller lack alignment). To date, nearly all search fund research has focused on buyers, meaning search fund entrepreneurs. Research is abundantly available on various aspects of a buyer’s journey – from raising capital to searching to acquiring to operating. However, little research has focused on the important first act of the search fund story – the seller’s background, mindset, and priorities. It takes two parties to complete a transaction, and sellers have been neglected in the current investigation of the full search fund journey.
In this case note, we aim to explore what business sellers most care about when selling their business. This will help search fund entrepreneurs better understand sellers’ goals and priorities to more successfully navigate search fund transactions.
In this case note, we will address the following topics:
* How search fund transaction dynamics differ from more traditional transactions
* What sellers actually care about most when selling their business
* How searchers can be a highly desirable solution for a specific subset of sellers
* How buyers can give sellers what they want to create a mutually rewarding situation
We conducted interviews with multiple business sellers and search fund entrepreneurs as part of our research. Based on these interviews and the rest of our research, we developed a six-point framework (see Figure 1) that outlines the top priorities of business sellers when deciding to whom to sell their business. We believe that sellers’ focus on these priorities is somewhat unique to search fund transactions. Therefore, the priorities may feel different and potentially even counterintuitive for search fund entrepreneurs with a past life in more traditional transactions (e.g., private equity, corporate mergers and acquisitions).
Despite how daunting it is for search fund entrepreneurs to source a transaction and simultaneously deliver to a seller elements of the priorities in Figure 1, there is great news for search fund entrepreneurs: you are an incredibly attractive choice for a subset of business sellers. We have identified six superpowers (see Figure 2) that search fund entrepreneurs are uniquely able to offer and that can be compelling and appealing to a specific type of seller. Of course, it is important to recognize that the searcher’s story and these superpowers will not resonate with everyone – and that is perfectly fine. It ultimately only takes one seller for a search fund process to be successful.
This case note focuses on conventional search fund acquisitions. These transactions typically involve longstanding businesses (going concerns as compared to venture capital–financed startups) with $3 to $10 million in revenue, approximately $1 to $3 million in EBITDA* and 10 to 40 employees. Through a search fund, one or two entrepreneurs aspire to acquire a single company fitting these criteria, with the intent of taking over day-to-day management of the business post-transaction (commonly as president or CEO). As part of the transaction, the seller normally transitions out of the business due to retirement, health, or other reasons. In this discussion, we will use the words CEO and seller interchangeably and the words entrepreneur, searcher, and buyer interchangeably.
Search fund acquisitions are essentially nano private equity transactions (although, in search fund deals, the searcher becomes the post-close CEO). Accordingly, it is not surprising that nearly half of all traditional search fund entrepreneurs come from a professional transaction background (i.e., private equity, venture capital, investment banking). Many technical skills learned in professional transactions are transferable to the search process, including market research, financial modeling and analysis, and deal structuring and negotiation.
However, even though the overall concepts are similar, the underlying deal process, transaction, and buyer–seller dynamics can be vastly different in a search fund acquisition (see Figure 3). This disparity becomes starker in the move from small, lower-middle-market deals to large, multi-billion-dollar buyouts. For example, small business sellers typically require search fund entrepreneurs to prove that they have the capital to consummate a transaction, sometimes requesting to speak with the largest expected investors and see bank statements for proof of capital. Funding sources are typically taken at face value with more institutional transactions, given a multi-billion-dollar firm’s track record, reputation, and size. In addition, valuation mostly serves as a gating factor to conversations in search fund transactions, and sellers are seeking a fair number. Once a general valuation is agreed upon early in discussions, the focus of conversation normally shifts dramatically. In larger, non-search transactions, valuation is the center of focus throughout the transaction, and due diligence focuses on informing where valuation should culminate.
Furthermore, in larger transactions, the seller is often a private equity–sponsored entity exiting to another, perhaps larger, private equity firm, or a strategic buyer. In the search fund world, the seller is universally the principal owner who is selling the business, usually for a lifestyle reason (retirement, relocation, illness, or fatigue) as compared to a seller in a larger context who is often catalyzed by fund life dynamics and prescribed ownership periods. Search fund sellers can be passionate and emotional as first-time sellers, while sellers in larger deals are often polished and experienced professionals who have bought and sold businesses endless times, resulting in a highly choreographed process with well-defined norms and expectations.Finally, in a search transaction, the due diligence process is very relationship- and trust-driven, and it is primarily conducted directly between the seller (i.e., CEO) and the buyer (i.e., search fund entrepreneur), with limited utilization of third-party specialists. As the search fund entrepreneur plans to take over the operations of the business, the seller is focused on getting to know them (and their spouse, if applicable) personally to understand if the company and employees will be properly taken care of. Larger transactions are typically more data- and information-driven, with several third-party specialists involved. In terms of the timeline of due diligence, it is common for search entrepreneurs to experience a six-to-nine-month diligence process where it may feel like they are the only one pushing the transaction along. Conversely, larger transaction processes are more complex, working off a detailed diligence schedule with multiple professional parties highly incented to drive the process along constantly.
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Gilbert & Pardue Transaction Advisors (GaP) is a Houston-based business advisory firm serving lower middle market and middle market business owners from coast to coast through representation for Mergers & Acquisitions (M&A).
Matt Gilbert and Bret Pardue established GaP to provide owners of lower middle market and middle market businesses – those businesses generally enjoying annual revenue of $10-$80 million – with the quality of M&A representation and value-enhancement services previously only available to upper middle and large businesses. GaP brings highly experienced executives, sophisticated financial and marketing products, proven-effective processes, and fully-integrated expertise to every engagement. No other M&A firm serving the lower middle and middle markets provides the quality of representation and transactional expertise that we do.
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