CONSIDERING SEARCH? A REFLECTION ON 4 YEARS IN THE TRENCHES
Hi. I’m Nick Haschka, co-founder of Cub Investments (Cub) and co-owner at Wright Gardner, LLC (WG) based in South San Francisco, CA. Cub was founded in late 2016 to acquire small businesses from retiring owners, and to hold and grow them far into the future. We acquired The Wright Gardner, a 13 employee office plant services company, in early 2017 from its retiring owner with an SBA loan, a seller note, and some personal savings. Since then, we've acquired 7 more local competitors from their retiring owners, and recently also added a landscape maintenance brand in San Jose called Vargas Gardening to our family. We’ve modernized the combined company into a more efficient and effective organization that should be able to thrive for a very long time. WG has provided concrete affirmation of our personal and business philosophies. It has become what we had hoped for when we set sail. There may be a lot of luck involved, but such is life.
Nevertheless, we think there’s abundant opportunity for others to formulate their own Entrepreneurship through acquisition (ETA) pursuit as well. That is why I’m writing this and sharing it with you.
If you are interested in understanding the evolution of our thinking and our journey, below is a set of interviews and publications.
Value Hive Podcast (Episode 15) Mar 2020
Think Like an Owner Podcast (Episode 5) Apr 2019
Alternative Investor Podcast (Episode 38) Mar 2019
TWG in the Associated Press Feb 2019
Enterprise Radio Podcast Jul 2018
the Main Street Revival - My first original piece on ETA, with a unique focus on lifestyle / self-funded - Feb 2017
I also share lots of ideas on Twitter. Follow me @NickHaschka
So without further ado, here goes nothing.
I started in search in late 2016 after our venture-backed startup drove off the proverbial cliff at 90 mph and shut down. My partner, Anu Sharma, and I found ourselves unemployed and trying to figure out what would come next. We had both previously done the fancy stuff - e.g. management consulting, investment banking, exclusive MBA programs, Fortune 500s, and venture-backed startups. We had pursued the status achievement rat race in its full grandeur for more than a decade. Luckily, it was about the least scary time in history to lose your job. Unemployment was <2%, and finding a decent paying gig would have taken all of about 3 phone calls if that’s what it came to. We just weren’t ready to jump to the next thing without some real reflection.
We had grown tired of the startup life’s wild rollercoaster of weekly near death experiences. It had all just culminated in a painful unraveling. We were forced to let go of everyone we had recruited and hired, including some close friends and family members. As enjoyable as the ride often was, we had growing skepticism about the wisdom of such speculative pursuits. How likely were we really to arrive at a life changing financial outcome? Would that even make us happy? Were we just dogs chasing cars without realizing it? It seemed like perhaps we were. The intensity of the ride imposed real costs on our regular mental state that undoubtedly spilled over to our families and friends. It’s not that we regretted it - we didn’t - but we had identified the most important thing that had to change in whatever came next.
With young kids and growing families, we decided to prioritize lifestyle, our own mental tranquility, and our family time in our next pursuit. I had the benefit of personal experience here, as I grew up in a household with parents who operated this way. Thinking back to my own youth, I recalled the dads who were reliably in the stands for those 5pm Tuesday baseball games. My dad was always up there among them. The one common thing that connected them? Nearly all of them owned their own small businesses. They set their own schedules, made a comfortable living, had vibrant social lives, and showed up for every game. Every single game. Those were the men I set out to emulate.
I began to apply some new standards to my evaluation of potential career pursuits that 22-year-old me could never have predicted: Work can never be an excuse to miss my kid’s baseball game. If I choose this path, what’s the likelihood I miss things I’ll later regret missing? Is this going to lead me to doing things I feel like I have to do to be successful at work? Will those be things I eventually will never even remember? It’s incredible how many paths this test rules out. It’s more incredible how a new frame of thinking such as this can alter the entire course of your life.
Finding Your Why
The first thing I ask any ETA entrepreneur is Why? What are you after? It’s actually rare I get the depth of response I’d hoped for upon asking. I’ll explain.
Many of the people I come across who are interested in ETA have done everything “right”, and most of it came fairly easily. They’re used to getting in, getting the job, and working in and around elite circles of business and academia. I don’t say this to diminish the achievements, but rather to acknowledge that this is not reality for most people, especially those in the world relevant to ETA. Realizing and remembering that will be valuable as you contemplate an ETA path.
Our version of ETA is common on America’s Main Streets, but is seldom discussed in elite circles of academia and business. This is likely because our approach seldom results in the newsworthy stories that typically favor coverage - bold and ambitious pursuits driven by big egos accessing deep pocketbooks. We are definitely not that. Instead, we focus on the forgotten, invisible, and unremarkable businesses that do well for their owners and employees. This path is simply unlikely to ever result in Fortune Magazine-worthy headlines - nor yachts, private jets, or encounters with the titans of industry, finance, or politics. If you are used to running in those circles, you may get some funny looks when telling people what you are up to. Most won’t understand it, and some will think you’ve given up an otherwise very promising career. How sad.
I think, however, that following our approach is far more likely to result in a comfortable and fulfilling life. The path is rich in small successes, meaningful relationships, personal pride, and gratitude. The daily challenges faced by those who pursue it will largely be those of your choosing.
It’s important to keep in mind that our ETA model was developed during a specific phase of our lives as a reflection of our then current priorities and ambitions. Those continue to evolve. More importantly, they may not match or align with yours. To the extent that yours differ, it may require adjusting or throwing this whole idea out the window and starting over.
I’ve taken great inspiration from the late Clay Christiansen’s How Will You Measure Your Life, David Foster Wallace’s This is Water, Patrick O’Shaughnessy’s Growth Without Goals, and Bo Burlingham’s Small Giants - Companies That Choose to Be Great Instead of Big. I recommend checking them out and developing your own Why.
Before you do this, it really helps to know who you want to be, then all you need to do is be that. Simple, right? If it helps you, sit down and write about yourself from a future perspective looking backward. Don’t write your conference speaker intro. Write your eulogy. Then make sure the standards you hold yourself to will ensure you become that person you wrote about.
Getting Started in ETA
There are some premises I’ve learned to operate under that help me every single day. Many will sound obvious. But, they are easy to forget or ignore, especially when it’s convenient to do so. Forget them, and you have a much higher likelihood of wasting your time, making a mistake, getting duped, or finding yourself in a situation or circumstance you don’t want to be in. Some of these I’ve carried with me for some time, but others I’ve gained recently, or have intensified through my recent experience as a business owner.
Emotions matter a lot. This is your business, your life, your reputation, and your money. It’s not the same as working for someone else or with someone else’s money. These factors tend to mess with your mind and your emotions in ways that can make the obvious answer hard to act upon. Recognize that, and it will be much easier to make good decisions.
Debt and indebtedness are insidious. Its mere existence will affect you in ways you may not anticipate or even realize. Anyone you accept money from, especially investors, you are now indebted to.
Time is not free. Be skeptical of anyone who gives you their time for free. Figure out their motivation. If you’re comfortable with it, engage, and then figure out how you can satisfy that motivation.
Most long term planning is a trap. This may be least obvious and the most contrarian of these premises, but I’ve grown to believe this fully. For me, long term planning motivates me by making me feel like I’m not there yet. I’m deficient. I’ve got to get moving, work harder, and do more. While admittedly this can be helpful, it can also greatly distract from being fully present. I’ve learned to embrace a more goalless life, and it’s helped me tremendously.
Growth and scaling instincts can be counter-productive. If you are highly motivated, achievement oriented, and impatient, the tendency you’ll have to pursue aggressive growth goals can be a useful instinct to learn to suppress. It’s much easier to appreciate and enjoy what you’ve got if you aren’t too focused on how to make it 10x bigger or 10x better. It can be helpful to second guess this instinct and think about how ways 10x bigger is actually not better, or 10x “better” could actually make your life worse before you step on the gas.
Every decision has trade-offs. Make sure you always know what they are. If a decision appears so obvious that there are no trade-offs, you haven’t thought about it hard enough.
With that foundation, it’s time to get to the tactical stuff.
Strategic Rationale for “Job-Buying”
I strongly believe the best opportunities for first time self-funded entrepreneurial acquirers are in the “job replacement” market, where the seller’s discretionary earnings (SDE) falls into the $200-500K range. I call this job replacement because in most cases, you are basically acquiring the owner’s job. In these businesses, purchase multiples are low (typically[redacted]0x SDE), the buyer population is small, and most potential suitors are unsophisticated and under-capitalized. This creates real competitive advantage for first time entrepreneurial acquirers. In the best cases, where the multiples will likely be highest, this is a pretty cushy job you’re buying. That’s a really good thing if you can find it.
Contrast this with the typical search fund or lower middle-market private equity acquisition venture. With few exceptions, they cannot acquire businesses earning less than $1M/year for the ownership. Earning your money from compounding fees and carried interest requires a large enough base to compound from. In addition, heuristics and experience tells them that businesses any smaller are inherently too fragile and lacking in basic institutional durability. There are not distinct roles between owners and management at such a small size. Transaction costs are too high given the level of rigor and documentation required to transact. For these reasons, any smaller and it’s often just not worth it for the sponsors or the limited partners (LPs).
While we wouldn’t categorically shy away from the $500K-1M earnings range for potential targets, at that size range, risks to capital-constrained buyers start to compound exponentially. There are many more well capitalized buyers competing. Purchase multiples tend to increase, which reduces relative debt capacity, thereby making the cash required to close increase disproportionately with the deal size. There’s more personal down-side risk for sponsors who still must guarantee debt (almost always). The loan amounts (which are personally guaranteed) quickly begin to surpass the aggregate net worth of more and more sponsors. The difficulty and risk of pulling off an asset purchase that large, which is much more protective for the buyer, starts to skew the calculus toward stock purchases. Transition mistakes destroy a lot more value, and if finances were already stretched to make the purchase, buyers can be left in sticky financial situations.
On the other side, deals under $200K of SDE, while not fundamentally bad, tend to pencil out as too small for anyone who would otherwise expect to be making six figures working for someone else. The multiples at the very low end are not much lower, while the businesses tend to be meaningfully more fragile and owner-dependent. There’s often a more fundamental reason behind why the owner is making little more than they’d make if they had a job, yet is assuming all the risks and difficulties of small business ownership. We think it’s not wise to spend your time trying to figure all that out when there’s plenty of larger deals to pick from.
The Problem with Search Funds
Private equity firms are sitting on more “dry powder,” or un-invested capital than ever before. The amount of dry powder held by private equity funds increased to $2.5 trillion in 2019, up from roughly $400 billion in 2000
Atta Tarki, ECA Partners in Entrepreneur Magazine
Nearly anything in the size range typically pursued within an investor-funded search is going to be pretty heavily shopped. In these competitive situations, a "fund" with no money waiting around hardly stands a chance of getting a decent deal unless they are going for something where they have uniquely relevant and valuable experience.
For example, we invested in a deal where the sponsors were former boutique investment bankers who had specialized in large medical debt financings at their bank for several years. They ran a highly targeted and systematic search for over 2 years. Eventually they bought a small, but well positioned medical lien funding company with acquisition financing from a major PE fund. They brought in an experienced CEO who they had worked with as bankers, and had him lined up to step in at closing, after being part of their process the whole way. They invested a meaningful amount of personal capital into the acquisition to show their commitment as well.
I think many in the investing world may be misled by the eye-popping statistics promulgated by the Stanford Search Fund study. Specifically, they conclude there’s been 33%/year aggregate pre-tax IRR for the Search Fund asset class from[redacted]Nothing against their methodology, but projecting these findings to the future, as many seem to be, is probably unrealistic. Even recent returns are based largely on the world as it was a decade ago and before when there were few search funds, few exits, and a truly elite group of entrepreneurial pioneers.
I get that the entire premise of a Search Fund depends on creating your own luck with volume, but I see a bit of a bind out there with as much dry powder out there chasing the lower middle market as there is currently. If the deal's not shopped, I question whether the seller's mind is even right - what state is the company in with that kind of person at the top? Is someone going to come to their senses and throw a wrench in the closing? If the deal's shopped, two possibilities. If it's good, they'll have multiple offers and an unfunded group will be highly unlikely to succeed. If it’s not good, then well ... it's not good.
The main exception I see here is people looking for fairly badly run companies with fundamentally good positioning that just need a lot of work. To me, that's what I'd be looking for if going "big". I'm not talking turnaround or distress situations where the businesses are hemorrhaging cash - that's a different thing - but rather, businesses with unimpressive margins and mediocre-at-best management talent and processes. Try raising money from LPs with that pitch.
This is all fine and well, but I think there’s a much easier way that doesn’t take 2+ years of your life to get your first at bat. I prefer to shop for very small brokered deals where they are being marketed to buyers, but there is simply a highly limited buyer population. In short, you get your pick and will rarely lose out if you make an offer and are determined to close. These can be anywhere from sub-mediocre to slightly-good businesses operating in (or proximate to) very good customer niches and/or local markets. With these situations, some management work and financial discipline can multiply the free cash flow in a year or two.
For example, we’ve acquired 8 companies in four years like this. The average multiple is <2x SDE and we’ve only paid >3x SDE once (for the first one, which was objectively the best company, though not the highest yielding deal). Deals like this are a dime a dozen, can be found and acquired in <6 mo. If an average search is 2 years, you then have 18 months to turn it into something you would have wanted if you were searching. The difference? You've paid yourself and increased your equity value the entire way. You own nearly the whole thing, and have almost no leverage (relative to the size of the business) at the 2-3 year mark.
Finding the Business & Job You Want
Within the job replacement market, we like businesses that are simple to understand, reliably profitable, and have a robust recurring demand profile from a durable customer base. We also prefer businesses that are service-oriented, and do not consume a lot of cash to grow. It’s advantageous when the acquired business serves (or has the ability to serve) a customer niche where there is a non-cyclical tailwind propelling growth. In short, we want to position our businesses to benefit from overwhelming and immutable economic forces in order to create the greatest probability of success.
We put high value on businesses with a long history, a unique and valuable niche, and a strong motivation to exit fairly quickly. Niche businesses competing in a fragmented industry structure with relatively unsophisticated and under-capitalized competitors are also desirable because of the potential for earnings accretive add-on acquisitions.
In addition to the business’ customer demand profile, it is also important to understand the job you are actually buying and ultimately replacing when the owner is gone. What does s/he do every day? What of those things am I currently comfortable doing? What can I learn quickly? WIll I ever be as good as s/he? Can I hire someone else who would be? Is there anyone else on staff that does that? Is it likely I can be better than him/her?
The best job you can buy is the one where you are pretty confident you can work your way out of it after some reasonable amount of time, adding quite a bit of value along the way. After all, that’s the goal of pursuing a situation where you are capital, not labor.
Best of luck out there!