After more than a year of grueling, frustrating, and lonely searching, I'm glad and relieve to announce that today I officially closed on my first deal! I've been active on this forum, picking other people's brains and asking for help, so I only find it fair to share some of my experiences and what I've learned with you all.
I am a self funded, solo searcher, so everything below will be written from that perspective.
First, for those of you curious about the deal specifics (because I always am): I bought a 100% residential lawn maintenance company based in NJ. The company averages about 2.5mm in revenue, of which ~70% is recurring annual contracts. After deducting $150k for owner's salary, I expect the company to average (assuming 0 growth) 550k in EBITDA. I paid $2.3mm for the business (including 115k of net working capital which I negotiated into the deal), of which 1mm was equity, 825k SBA loan, and 475k sellers note.
Things I learned/experienced along the way:
1. It is HARD. No matter what you may have read, or what other people have told you, it is always going to challenge and frustrate you in more ways than you can imagine. I thought I thoroughly prepared myself and set expectations for a grueling ordeal. It was at times much more agonizing and demoralizing than even my best preparations. Doing a search fund, especially as a self funded solo searcher, is not the right path for everyone. I highly advise you do the work beforehand to determine if this is indeed what you want to do.
2. There is no "right" way to run a search process. I know there is somewhat of a canonical template as set by the HBS or Stanford primers, and I encourage everyone starting out to read them. But don't be afraid to tweak things to fit you. Be creative in choosing parameters and structures that best suit your needs and risk profile. Things you should think about adapting to your own situation include:
--Geography: You don't have to do a nationwide search. I did a highly restrictive search to NY/NJ/CT. Obviously some localized geographies are better than others. Again, figure out what best suits you
--Sourcing: While I understand why people might want to do the cold email blast method or the "river guide" method of sourcing, I also think there are significant drawbacks to those. I used exclusively listed brokered deals as my sourcing method. Of course this has its own advantages/disadvantages, but it suit my needs best.
--Deal Size: I've noticed a lot of questions about optimal EV of the deals to pursue. Personally I find that to be a tough question to ask someone else. No one really can answer for you, besides yourself, what your risk/return profile looks like and what you are hoping to achieve. For me, I was trying to build a foundation on which I can lean on to hopefully do bigger and better deals going forward. For that purpose, a 2.5mm EV deal worked just fine.
--Capital Structure: Again, this is a question I frequently see on this forum: how much equity vs debt to put on the deal, and in what form that debt should take (SBA vs some other form of debt). And again, there is no generic answer to this. Everyone has different financial situations and different risk profiles. The one thing I will say is, especially when you trend towards smaller EV deals without hard assets (e.g. service businesses), SBA loans are pretty much the only remote reasonable source of financing available to you. And yes, they do come with a non-negotiable personal guarantee attached. If you are not comfortable doing that, then search funding might not be for you. In my case, I wanted to mitigate my losses somewhat, so I have a rather sizable equity injection, made all the more doable by the size of the deal.
--Search Criteria: I certainly didn't start the search fund process thinking I was going to be mowing lawns. But I cast a fairly wide net, and what came back that checked enough boxes ended up being a lawn maintenance company. Figure out parameters that work for you, and don't be afraid where that leads you. Some people know exactly what industry they want to be in, and that can be good or bad. Don't be afraid to look at industries you've never thought about, or even knew existed.
--Source of Equity/Investors: I actually want to spend a little bit time on this topic. I want to be clear, there are multiple ways to fund your equity injection, and I highly encourage you to explore different ways to fund your equity portion. I purposely did not want to take on traditional search fund investors, as I believe it is a horrible set up for me personally. I know there are a lot of search fund investors on this forum, and a lot of people who seek traditional investors, so if you'd like to know more about why I eschewed them, feel free to send me a PM. In my case, I did a straight equity deal -- no step up provisions, no preferred equity, no vesting of searcher equity. To entice investors, I added some additional sweeteners into the deal, like a waterfall clause. The hardest part was getting over the personal guarantee part (the fact that I have to personally guarantee the loan while the investors don't, yet they share in full upside pro rata with their investment while having limited downside). However, if you believe you will be successful, then that is a more tolerable fact. My advice is, do your homework and make an informed decision based on your financial circumstances and risk profile to determine the best way to fund your deal. Just because Stanford and HBS assumes a traditional search fund investor program doesn't mean you have to go that route. Be creative. Be unique.
3. Searching can be very expensive, or it can not be. When I first started, and I realized all the things I had to do (legal, accounting, etc) I was afraid that costs would spiral out of control. As I went through the process, however, I learned more and more how to manage them. I learned what I could do on my own, what services I could live without, and how to get the most out of what I pay for. This was made somewhat possible because I don't have traditional institutional investors, and I'm not looking at a $25mm EV deal, so again, this is just my experience. To give you an idea, all of my professional fees incurred (aside from SBA fees), from creating LLC to drafting PPM and investor docs to due diligence through closing today, total less than $4,000. Maybe it will come back to haunt me later, but as of now I don't feel like I missed a beat. So yes, build your team early and decisively, but don't overspend on them (unless you're flooded with cash).
4. When you go through your screening process, I found it worked in several tiers. Tier 1 was the easiest, screening for industry/size/geography/etc. And if you use a listing service like BizBuySell or Axial or whatever, you can set filters so it pretty much does Tier 1 for you. Tier 2 was also relatively easy when you take a closer look at the description and nature of the business. For example, I love service type businesses, but while I love lawn maintenance, I absolutely abhor landscaping. Once you've gotten to the point of getting the offering docs or memorandum or w/e they call it and you see the financials, here are some of my immediate red flags I've noticed along the way. I'm going to assume everyone is financially intelligent, so I'll skip the obvious ones like declining revenue/margins or customer concentration and instead focus on ones I didn't think about at the beginning of my process:
--Ballooning Revenues: I've seen plenty of companies where the past 5 years of revs looks something like this: 2mm, 2.2mm, 2.3mm, 3.5mm, 5mm, 7mm. While to some that seems great, to me it's a HUGE red flag. Think about it. Sellers don't suddenly wake up one day and decide to sell. They probably have planned it several years ago. What unscrupulous people will do (and I've seen this first hand) is they'll frantically get every sale they can get to pump up the numbers, because they know TTM numbers have the most weight to valuation. But what ends up happening is either they massively underinvested to keep up with the sales growth (so the buyer is staring at a giant capex bill on day 1 -- remember, capex is a balance sheet line item and doesn't show up on the income statement) or they acquired a lot of low quality/low margin business that isn't replicable. In these situations, I'd dig real deep to see if that explosive sales growth is legitimate and can be expected to continue
--Off Income Statement Items: For those without an accounting background, pay special attention to this. Brokers and sellers love to show you income statements showing how much money the company earned. But there are lot of negative cash flow items they can hide off Income Statement on the balance sheet, such as capex spending or account receivables. I had one company asking $4.5mm and showing $1mm EBITDA on the income statement. But on further digging it spends about $700k/year on capex. Hard Pass. Another one claimed it had $1.7mm of EBITDA, but literally ALL of it was in the form of AR. Again, hard pass.
--Number/Nature of Addbacks: Do not be concerned when the seller's Income Statement shows +1mm EBITDA but his 1099 Tax Filing shows +50k of Income. This is perfectly normal. After all, if you owned a business, wouldn't you want to take as many writeoffs as possible? So having a lot of addbacks isn't necessarily a bad thing, but some are just more difficult to justify/track than others. I've seen businesses that want me to accept 30 different types of addbacks. I've had other businesses that effectively run all the seller's personal finances through it. I just don't think that's worth my time to try to sift through, nor could I be very confident of my analysis. In my case, my seller kept personal and corporate finances separate, and only had 5 line items in the addbacks section. Oh, and did I mention 65% of the addbacks was in the form of owner's salary, justifiable via W2s? Yes please.
--Lack of Documents: I believe if you want to convince a buyer to pay top dollar for you business, you better have your ducks in a row. That doesn't mean simply producing an income statement or showing me your tax returns. It means giving me monthly statements of your credit cards. Monthly bank statements. Copies of checks you wrote, etc. If the seller is unwilling or unable to provide those documents, I don't waste my time and move on.
5. Don't just be a numbers guy. I know a lot of recent MBA grads want to flex their financial modeling prowess, but don't get lost in the weeds and overlook the most important relationship you will have in this process: the seller himself. After all, nobody knows that business better than he does. So it's very important that when you speak/interact with him, you feel that he's a trustworthy guy. After all, in the world of small business, you can only do so much due diligence. There is a large element of trust here, and if you don't feel 100% confident you can trust the seller, that's a big big point to keep in your mind. Or if your personalities don't jive at all, it might be hard to work together post closing. And remember, this is a 2 way street. Sellers are often emotional about letting go of the family business. They want to make sure they are passing it on to good hands. Take care of the relationship you have with the seller and it'll do you wonders during due diligence and beyond.
6. Hammer out all the details ahead of time. I've seen multiple threads of people saying you should send LOIs early and often. I'm not sure I necessarily agree with that. I took a lot of time to craft and hammer out details in my initial LOI, and I think it saved me a lot of time and headache down the road. A lot of deals breakdown at the later stages, after a lot of time has been spent on due diligence, because the two sides left certain things until the end. I would advise against that. I'd rather spell out everything upfront -- including purchase price, terms of sellers note, net working capital, lease terms, any contingencies you want to build, etc. I spent a difficult 3 weeks before submitting the LOI negotiating, but once that was done, it was a straight shot to close. Once I completed due diligence, I was confident we would close because there was nothing left to negotiate on. I think it would save you a lot of time and potential headache if you front loaded all your negotiations.
7. This is somewhat of a random point, but I would actually suggest to choose a closing date on a Monday as opposed to a Friday. Like many, my natural inclination was to choose a Friday closing, which is what I did. But remember, everything kicks in on closing date: your loans, your rent, your insurance premiums. So effectively, by choosing a Friday close, you are needlessly paying 2 days (Sat and Sun) of costs! You can avoid this by choosing a Monday close. In my case, it came out to something like $1500 wasted. In the grand scheme of things, it's not the end of the world, but hey, in the beginning every dollar counts.
8. ASK FOR HELP. There is so much you don't know, and even more you don't know you don't know. Rely on your personal networks, your professional networks, and your SF community for help. Talk to everyone to get smarter and make more informed decisions. No one has all the answers, but 100 people will get you pretty close.
I know there is much more I learned, but I figure if you're still reading at this point, you probably don't want to read any more. So I'll leave it here and you can feel free to PM me if you have any questions. Of course, I am happy to recommend the professional services I used for the deal.
Be Creative. Take Risks, and Happy Searching.