(photo from graduation ceremony with top management team) 


We spoke with Angel Alvarez Cadavieco whose search fund, Lottus Capital, acquired Universidad Tres Culturas (UTC). Angel is now a partner in ALZA Capital, an investor in search funds. In this Part I, we discuss his search experience.

How did you get on the search fund path?

I first learned about the search fund concept back in 2011 while I was getting my Master's at London Business School. The private equity club organized a panel about search funds and a few successful searchers and investors such as Simon Webster, Will Thorndike and Rob Johnson came to LBS to talk about the idea of starting a search fund. Right away, I fell in love with the concept.

Before LBS, I had spent four years working in M&A and private equity. I had always had a strong interest in becoming more involved in the operational side of the business, so I thought the search fund model was the perfect fit for what I was looking for. This panel took place only a few months prior to graduation, and by then I had already accepted an offer to return to JP Morgan. So I decided to go back to JP Morgan and gain a couple of additional years of experience before I finally decided to start my search fund, Lottus Capital, in 2013, with my two partners, Guillermo and Jesus.

How does a partnership work with three people?

It's definitely interesting and has pros and cons to it. We're probably one of the few or the only search fund of three people that I've heard of. The three of us were very complementary both in terms of skill sets and our personal networks, so overall it worked out really well for us.

There are a few things that are a bit different -- in comparison to the solo or 2-partner search fund -- and create certain complications. For instance, we used the same budget that the average 2-partner search fund use###-###-#### ,000 dollars --. That implied that our salaries during the search period were considerably lower than those of most searchers. We didn't really mind having a lower salary if that was going to result in a bigger chance of success in the future.

 Another complication that we faced was that we needed a company that was big enough for the three of us to fit -- not only in terms of size (EBITDA and revenues), but also in terms of the amount of actual work in the company for us to split among the different roles. Overall, it worked out very well for us especially given the size of the company we ended up acquiring -- with over 200 employees and a number of different functions and departments --. We were able to split roles among ourselves, each taking leadership positions in the different areas of the company, which was a great part of our success during the whole search fund process.

Did the three of you conclude that you wanted to start a search fund together or was it that the two of you who decided and one of you brought somebody on?

I had been close friends with Guillermo and Jesus for several years. I knew Guillermo from undergraduate and both of us coincided living in Switzerland right after business school. I knew Jesus from our professional experience; both of us started our careers in investment banking, and we had become close friends back then. I had conversations with both at the same time. Both of them also learned about search funds while at business school and also had a strong interest in starting a search fund. So, we met for a weekend in Geneva and discussed whether it would make sense for the three of us to launch it together. We all came to the same conclusion that it would definitely make sense. We were willing to lower our return -- versus a solo or a two-partner search -- if that implied a potential better success for the project. So, yes, the three of us came the conclusion at the same time. Ever since, the partnership has been very solid and we are still close friends today.

Did you identify education as a sector you wanted? How did you find your company?

Education was one of our sectors of preference since the very beginning. We analyzed a lot of companies within the education spectrum from kindergartens to high schools and to higher education.

We were enthusiastic about the education industry and within the sector we had a strong preference for higher education as we believed it had the most attractive fundamentals, especially in terms of profitability, fragmentation and opportunities for growth. Early in the search process we got in touch with all the local investment banks, brokers and M&A boutiques and explicitly asked them to please keep us in mind in case any opportunities within the education space came up. That's how we ended up getting this opportunity from a local investment banking boutique.

Specifically, we were invited to a competitive auction process. There were only four players in the process, including our search fund. The remaining competitors were two local family offices and a global private equity fund that had a strong interest to invest in the education sector in Mexico.

We had a big advantage versus the other competitors. The two family offices already had private universities with well established brands. They wanted to acquire this company not so much for its brand or reputation, but more so for the assets. They were interested in changing the name of the university and converting it into their own original brand. The sellers were not too happy about that plan, as they wished to preserve their legacy. Their aspiration was to see the company they had started 20 years back becoming a well-recognized nationwide university. So, that gave us a considerable advantage versus the two local family offices since our plans for the business were aligned with those of the sellers.

The global private equity fund had a strategy similar to ours. However, they didn't have a top management team to put in place, so they wanted to lock in the sellers operating the company for a number of years. The sellers were not really looking for that either, which again gave us an important advantage going into the competitive process.

At the end of the day, even though we didn't put the highest bid we were able to lock in exclusivity for six months -- given the situations just mentioned --. During those six months, we ended up closing the deal. It also helped a lot to gain the exclusivity the fact that we established a strong personal relationship with the owners, which we still keep today.

It’s been awhile, but are there any hitches that come to your mind that happened during the process of closing your deal or maybe looking at an earlier company?

Sure. One recurrent difficulty we faced was the lack of information. In Mexico obtaining any type of financial information on private companies through the web or different databases is almost impossible. You need to spend a lot of your time -- a lot more than in developed markets -- reaching out to companies that, at the end of the day, you're not sure if they are a good fit in terms of size and profitability. You are approaching them pretty much blindly. To complicate things a bit more, most of the information of these small-sized family-owned companies tends to be really messy, as most owners mix their own personal and family expenses with the finances of the business. As such, you need to spend a significant amount of time right at the beginning trying to figure out whether or not the EBITDA of the company makes sense for your search or not. That was, by far, a difficulty we faced constantly during our search process and that I would say most searchers in Mexico and Latin America typically encounter.

Looking back at our specific search, the biggest hitch we had was spending 25% of our search time trying to close a transaction that failed in the last minute. In month 6 of our search we were able to lock in exclusivity to acquire a business in the consumer space. From month 6 to month 12 we entered into a full-blown due diligence process to acquire the company. We were very, very close to closing the acquisition, but two weeks before signing the deal, the seller decided to back out. He changed his mind in the last minute of the process and decided not to sell the company. At the end of the day, we pretty much lost six months…

--Ugh --

Yeah###-###-#### analyzing and trying to nail down this acquisition which, unluckily ended up not happening. This was probably the biggest disappointment we had along the search process.

How did it work from a decision process with the three of you? For example, I could envision a scenario where 2 of you might be keen on a company and one was not. Would the one person have veto or would you try to work towards consensus?

We tried to work through consensus. At the end of the day, consensus really meant that the three of us would feel comfortable with the target company. If one of us didn't think it was the right company to buy, the other two partners would need to convince that third partner to make sure that the three of us were fully on board and a 100% convinced with going forward with that acquisition before we submitted a LOI and formally presented it to our advisory board. On one hand, it definitely made us reject more deals than other traditional searchers as it is obviously more complicated for the three of us to agree on every investment opportunity. However, on the other hand, you could also consider it as an advantage, as there were three completely different points of view that had to agree in order to move forward with the process. We sent about 25 LOIs during our search process, so, as you can see, we definitely agreed on many things along the way and ended up acquiring a company in which the three of us were extremely convinced about.

In talking to searchers who are partners, they often have mentioned that having a partner means you've got more horsepower on the search and you can divide up the activities a little bit better. They feel you can get more accomplished because of that. Is that the same having three on the team and then how did you divide up your activities

Yes, I agree. Obviously, you have a lot more horsepower during your search but it is even more critical during the operation of the acquired company. Being three of us was definitely very helpful. For example, one of the things we didn´t do -- and probably also because it wasn´t as common back then -- was hiring interns during our search process. Given there were three of us we were able to split all of the work among ourselves. For example, one of the things we did was to divide the different sectors of interest and each of us took leadership over different industries. That allowed us to bring a higher number of opportunities on board and become experts in multiple sectors.

Additionally, Guillermo is from Monterrey. So even though our headquarters were located in Mexico City, Guillermo spent a significant amount of time in the northern part of Mexico looking for opportunities in Monterrey and the surrounding cities, while Jesus and I spent more time looking at opportunities in the central region of Mexico. So, being three partners definitely helped us broadening the geographic outreach.

(photo taken at exit with investors/advisors)

What lessons have you learned about searching that you didn't know when you first started?

There are many lessons learned along the process. Let me give you a few highlights of what I would probably say are some of the key takeaways:

One: Have a former searcher as part of your investor group. It’s not always possible, but if you can it is a big plus. They can definitely provide valuable advice and guidance and even more so if they have done their search in your same country or region where you are conducting your search process.

Two: Hire interns; they can be of considerable help. You should spend your time on the most value-added tasks -- such as having the one-to-one in-person meetings with company owners -- while the interns can concentrate on doing the preliminary screening as well as the initial reach out to companies, among other relevant tasks. Interns can be valuable and it’s something that wasn´t as common back then, and unfortunately we didn´t have the opportunity of having them.

Three: The “equity gap” happens way more often than people think. I would strongly suggest having two or three institutional investors with deep pockets on your investor group. They can add value especially once you get to the acquisition round. Raising equity from external investors while closing a deal can be very complicated and stressful. So, if you are able to have some of those institutional investors in your search since the beginning and avoid having to look for additional capital at the time of acquisition, that can help to a large extent.

Four: If you're thinking of funding part of your acquisition with debt, start your conversations with the banks early in the process. Most Searchers from what I've seen, at least in Latin America, underestimate the complexity and the time that it takes to convince a bank to provide acquisition financing. I would suggest that as soon as you send an LOI and get green light on a deal, you start those financing conversations with the banks.

Last one: Be realistic and try to be as effective as possible on your search. Don't spend time on opportunities that don't really fit with the characteristics of the search fund model or where the seller’s expectations are very far away. Those opportunities will most likely fail and spending time on these opportunities is not the most effective way. At the beginning of your search you may think that 24 months is a significant amount of time; however, once you get into it and look back, those 24 months go by really fast. So, spend your time wisely and effectively and only dedicate time to analyze opportunities that clearly fit within the search fund model.

These are just 5 of the many lessons learned along the way!

(photo from inauguration of new University campus (their 6th) with the mayor)