Steve Ressler – How to Invest in Search Funds – Ep. 62

My guest today is . Steve has been an entrepreneur for much of his career in software and government services and has recently been translating that experience into search fund investing, among other projects. A good portion of our discussion focuses on evaluating and scaling niche software businesses and whether niche means limited growth prospects or a formula for other markets. I’ve gotten to know Steve pretty well and he’s an absolute wealth of knowledge for searchers interested in software and government services, please reach out to him if those are areas of interest for you.

Over the course of this episode we discuss Steve’s experience being a founder and having his company acquired, what he looks for in search investing, tailwinds in government service businesses, and whether individuals should invest in self funded searchers.

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Think Like an Owner Sponsors

Live Oak Bank – Live Oak Bank is a seasoned SBA lender focused on search funds, independent sponsors, private equity firms, and individuals looking to acquire small companies. Live Oak has closed billions of dollars in SBA financing and is actively looking to help more small company investors across the country. If you are in the process of acquiring a company or thinking about starting a search, contact Lisa Forrest or Heather Endresen directly to start a conversation or go to www.liveoakbank.com/think.

Hood & Strong, LLP – Hood & Strong is a CPA firm with a long history of working with search funds and private equity firms on diligence, assurance, tax services, and more. Hood & Strong is highly skilled in working with search funds, providing quality of earnings and due diligence services during the search, along with assurance and tax services post-acquisition. They offer a unique way to approach acquisition diligence and manage costs effectively. To learn more about how Hood & Strong can help your search, acquisition, and beyond, please email one of their partners Jerry Zhou at --@----.com

Oberle Risk Strategies – Oberle is the leading specialty insurance brokerage catering to search funds and the broader ETA community, providing complimentary due diligence assessments of the target company’s commercial insurance and Employee benefits programs. Over the past decade, August Felker and his team have engaged with hundreds of searchers to provide due diligence and ultimately place the most competitive insurance program at closing. Given August’s experience as a searcher himself, he and his team understand all that goes into buying a business and pride themselves on making the insurance portion of closing seamless and hassle-free.

If you are under LOI, please reach out to August to learn more about how Oberle can help with insurance due diligence at oberle-risk.com. Or reach out to August directly at --@----.com in sponsoring? Send me an email at --@----.com transcript:

Thanks, Steve, for coming on the show. It’s been fun to get to know you over the last few months or so, and following you on Twitter. I’m surprised it’s taken us this long to get an episode together, but I’m excited to have you here. We’d love to hear about your background and how you got into SaaS and search investing and all these other projects you’re working on.

I really enjoy the podcast and the community. I think one of the most fun things about the podcast is getting to see folks I know from Twitter, and then meeting them on individual phone calls, and then hearing their full stories on the podcast, so great to join the community, happy to share my background. I joke I’m a mix of my parents, so I’m third generation government employee on my dad’s side. My dad worked for the IRS for 40 years, which is definitely not cool when you go into a new school as the tax agent’s dad. Then my mom’s side is all entrepreneurs. My granddad had a series of businesses.

One was Morrie’s In & Out. He saw McDonald’s early, and created his own version. He also owned a aluminum siding company. He retired in Wyoming, and got crushed by inflation and created a new business, which was a fire extinguisher services businesses. It sounds like a search business. I’d want to own that. Those things collided, and I have a career in government entrepreneurship. I ended up going to high school in Ohio, went to Miami of Ohio for college, around the Ben Roethlisberger era if folks are a sports fan or one claim to fame. I went to University of Pennsylvania for grad school right away under a homeland security scholarship.

I thought I wanted to be a professor. I had many zings and zangs in my career, but that was the original goal. I was in a PhD. program in sociology. My wife finished her PhD. We met there. She’s originally from Spain, and now is a professor at George Washington University. I realized I did not want to be a professor my second year when my office mate was a seventh year and said, “Maybe if I’m lucky, we’ll get a $40,000 a year job in rural Alabama, and maybe get 10 years, seven years later.” I said, “Wow, that’s a tough life.”

I went to go work for the government. I had to for my scholarship, and I spent five years in technology in the government, a real fun career, always loved the double bottom line of public service and having an impact. I eventually left and created a company called govloop.com. We launched in###-###-#### Basically, the idea around that time was a concept around vertical social networks. There was a company called Sermo at Boston. That was a social network for doctors. There’s one that was a social network for lawyers. I was basically creating the social network for government employees.

Basically, the idea was in government, all folks are on the same team. If you work at the City of Portland, and I work at the State of Oregon, and you work at Department of Health and Human Services, we want to connect and learn and share. That was the idea of that website. It grew from an idea to eventually over 250,000 members fed state local. We ended up selling the company to a software company based in St. Paul, Minnesota. It was called Gov Delivery. Our company got acquired, and there were about 70 people at the time. They were basically a MailChimp for government. If you’ve ever gotten an email from a government agency, say CDC during COVID, around Coronavirus, or here in the state of Texas, you got an email about renewing your hunting license, that’s them.

I ran a number of P&Ls, and was the chief marketing officer. We grew that from seven to 40 million ARR, and sold it to a private equity company called Vista Private Equity. Spent some time at Vista. For folks that don’t know Vista, they’re well known for a phrase that all software tastes like chicken, that it’s all the same, and they have a proprietary playbook of how to run great software businesses. Their founder, Robert Smith is a famous billionaire and has written a lot of interesting things about software, a new version of constellation software, folks like them. Sit on there for about 18 months.

We bought a number of companies, learned a ton, and eventually left that company, and joined a friend who had a small public safety software company called Callyo. A fun company, we’re about maybe 15 people in St. Pete when we join, and had a great run from two to eight and a half million ARR, and sold it to Motorola Solutions last year. It was just a fun ride there. My day job career has always been technology, software, growth, equity, SaaS, which you probably wonder, how does that relate at all to what we’re talking about today, search and ETA. Basically, it came out of two other passions of mine.

One is I always have loved investing. I was that dorky kid at 13, who had a Vanguard Roth IRA, and loved index funds, and graduated Buffett and Munger, and add into constellation software, and the outsiders in Thorndyke. I always loved value investing. Then I’d always also started loving entrepreneurship, and got quite active in the D.C. tech ecosystem as an angel investor, as well as the GovTech startup ecosystem. On the startup side, I basically loved helping entrepreneurs, loved backing smart people, but I did not love the 20 strikeouts for one Grand Slam Math. That is the power law of venture capital.

I love the more value investing. A friend of a friend had done search, and it just clicked in my mind that this is one part value investing but one part startups and backing great entrepreneurs. Started investing in search funds and ETA about three years ago. Over the last few years, I’ve invested in 15 plus deals at the deal level of self-funded search, traditional search, U.S., internationally, as well as backing traditional searchers, and just been having a ton of fun. That’s been my background, and it’s a great community to be a part of.

With software being a lot of your background, is that also your focus of search funds, or do you view search funds partly as a way to expose yourself to other industries?

Both. One, when I got involved with search funds, I had no idea that there was as much software as there is. If you look at the recent Stanford studies, I think software has now become the largest category of traditional search of industries done. There’s a lot to like about software, so there’s a reason why it trades high in the public markets, usually 70% to 80% gross margins, high recurring revenue. It’s a great industry to be in. I found in the search community, while there is a lot of software, there’s not a ton of operators with software experience.

That’s one place where I felt I’ve been able to be a value add, and so a lot of the searchers I bagged, I’ve been able to leverage some of the lessons and playbooks I’ve used in my own life and software. That’s been fun, but I’ve only done… Probably of the deals I’ve done, 25% have been software. The 75% have been the classic B2B services, health services, the dirty services across the category, and even done one ecommerce deal.

Have you found that throughout your software deals, and then your experience running software companies? Have you found that most of them do tastes like chicken, or is there quite a bit different flavor between each one?

There’s definitely playbook. I’m a believer in framework. You’ll see an ETA. There’s different frameworks like EOS for running companies or Rockefeller Habits. I think there are frameworks to running great businesses generally in managing teams. I think this applies to software, that software has similar but different metrics they follow, so there’s different metrics like the rule of 40, and net retention and gross margins. There’s different ways to go to market and sales playbooks that I think are pretty applicable across industry. I think there are a lot of elements that do taste like chicken.

I do think in each industry, though, it helps to have… There’s two types of software, generally. There’s horizontal software, so basically, software that’s applicable across industries, so I think Salesforce, there’s a CRM for… You can use that in any industry. Then there’s vertical software, which is just focused on an industry. Say, AVEVA does a CRM just for Life Sciences, or there’s an application tracking systems just for industries. I think, especially in vertical software, it helps to have that mix of software best practices, but someone that loves the sector and industry.

For me, in GovTech software, I think it’s helpful to have people like myself that have done government. They know this space. They really care about the mission, and then also have those chicken best practices, if that makes sense.

Absolutely. When you’ve thought through your experience with the two software companies, you were a part of that both grew substantially, and you now turn to searchers who are acquiring software companies. What kind of advice do you give them that help scale a software business?

There’s a couple common items that I think folks at the search stage, when they get involved with a software company, that are applicable. They’re not too much different when private equity gets involved with software. Usually, the software company, obviously, created some product market fit. That’s why they’re alive, and they have some revenue of searches buying it that’s probably somewhere in that three to 15 million in revenue, so they have customers. What often happens, though, the search stage when new folks come in, there’s often the under development on pricing is one.

As running a small business, it can be hard to change pricing, either different tiers or upping pricing, and so we often find there’s a great opportunity for growth, leveraging pricing. The second is usually, there’s an under investment in sales and marketing. Sometimes, that occurs because the founders of the companies are usually technical, and they don’t love sales. A lot of engineers, their dream software business is self serve, and you don’t ever have to hire a salesperson is a lot of folks dreams, and so they’ve never built out the methodology of hiring sales reps, creating sales plans, and commissions and quotas, and really building up great sales and marketing.

Then the last I often tell folks to focus on, which is the same in any business, the easiest next dollars from your existing customer. One stat you’ll see in software companies is called net revenue retention. This is how much revenue, say, of existing customers you get the next year. If you start with $100 at the beginning of the year, after the end of the year, with customers leaving and buying more stuff, how much dollars you have. If you’re a good software business, you should be over 100%. I always encourage folks to focus there.

That can be building customer success teams. It could be creating add-on features to sell back to your base as well. Like all these things, it takes time. In a lot of it, the first six months, you’re just getting in the seat and meeting the team and building buy-in. Then part of the journey is then creating the strategy and playbook for the next six, 12, 24 months.

I’m curious, what’s the most niche or unique software business you’ve come across?

There are niches for everything. I think that’s what’s funny when you want to cross. I’m trying to think of one I’ve seen. I just saw one for pool services. You see a lot of pool services companies and ETAs, good recurring businesses. There’s a software company that just serves that. You’ll see in government where I’ve done a lot of my work, you’ll see different versions of the same software just on population size. There might be a budgeting software company that’s focused on cities over a million population, and then you’ll find another company that all they do is focus on cities, only 10,000 population and below in X state that has this one compliance regulation that you need a specific feature.

It’s interesting how the businesses can grow. I think as an entrepreneur, you’re trying to find that nice middle, where you want a big enough addressable market, that the business can grow. Hey, if you’re selling to left-handed guys named Steve, that live in Ohio, there’s probably not enough of us to build a big business, so you want a big enough addressable market. But at the same time, you want it focused enough that you can reach customers in a cost-effective manner, or sometimes if the market’s so broad, it’s hard to know how to narrow down and focus.

I’d love to dive into that just a little more, and hear your thoughts on is there a dividing line where a company is too niche, too much like the kind of Bait and Tackle shop that it cannot grow, versus one that maybe they only address left-handed guys named Steve in Ohio, but they’re looking at… there’s an opportunity to expand to left-handed guys named John or something else, some other similar related business that could expand? I’m rambling here, but where do you think that dividing line goes?

I think you’re thinking about exactly the right way. Some markets are small, but have clear expansion, so a total addressable market of, say, 100 million for a software company is pretty small, if it’s, say, 50 to 100 million, but sometimes there’s clear adjacencies next door. Hey, you’re selling to pool services, but pay the same technologies applicable to lawn services, or go an extension. If you’re doing venture backed, or going for a large economics, you’re usually looking for a billion plus on the TAM size.

It’s a one common framework to use. I’m of the believer that you can usually grow the TAM. If it’s small, I’m still open to investing as long as there’s an entrepreneur in there that has a vision around it, and it’s a clear adjacency that is easy to get, because sometimes the adjacency is so big that it can be quite expensive, and that does work in a search model. For example, if you say, “Hey, we’re big in the US, but we really think we can go to Europe.” Well, that’s usually a pretty expensive to go internationally for bootstrapped or self-funded companies go international, even though the addressable market’s there. It’s hard to cost effectively do that often.

That makes sense. I’d be curious to hear a little bit more about your experience getting into search investing. If you think of the first probably six months of trying to build connections, and meet people and learn how search works, as an investor with the intention of making this a substantial role within your own life, how did you approach those first six months, and what did you start doing?

I mean, the good news is I feel like there’s some foundational literature in search, and that’s where I really started. I started with… They call it the Harvard Red Book, the guide to buying a business. I think it’s a great primer, then went to the Stanford study. Then they have the European version of the study too. I think those are a lot of great data and information there. I actually found podcasts were a great way to get learning too. There’s a number one… Chicago Booth has an ETA podcast. Obviously, your podcast covers not just search, but lower middle market, but you’ve got a lot of great folks that have been on this podcast.

Really, for me, I just started by learning and listening. Then I started getting active in community. I was pretty active on search funder and Twitter. What I love about this community is people are pretty open to taking phone calls, too. I keep a track of it. I’ve had 500 plus phone calls, I think, in the last two years, talking to searchers, investors, people in this space. That’s how I do a lot of my learning. I think people learn in different ways. One of my favorite things is just to talk to other smart people, and hear lessons, and this community is so giving. That’s how I learned a ton.

Then, I think, for me, it was trying to figure out, “Hey, where do I even get started?” For me, what I found in traditional search investing, it can be an expensive proposition for an individual investor. Generally, a unit would be $40,000, and the pro rata of that on a deal can be, say, 250 to 500K, so just to take a round number of 500K. If you’re trying to get a diversified portfolio of 10 searchers, that’s $5 million is a lot of capital to get a diversified portfolio. My first learnings were trying to do that and say, “That’s tough to do. I can’t do that.” For me, I’m buying a half unit of one searcher doesn’t feel like a diversified enough approach to this category.

What I did next is actually think what I recommend to a lot of folks, I joined as a small LP in a couple search fund to funds. I still recommend. That’s a great way. If you’re interested in investing in search, join as an LP. The first thing I did was join as an LP at Footbridge Partners, which is a great group. I think you’ve had Greg on the podcast before, Greg and David. That was how I got access to the category and really started learning a ton. Then as I did more there, I started getting reached out by some individuals around self-funded. Honestly, I didn’t even know self-funded was a thing, because you don’t hear about that much in the literature.

I think one of the first deals I did was a Stanford grad, had gotten to Bain who was looking to buy an Asian food wholesaling business in Austin, Texas that had some interesting tailwinds. Man, this feels a little different, but it’s got a lot of great things going on it, and I could write a smaller check into it. I started getting quite active in the self-funded search community as well, which was a ton of fun. What I found in that world was there was not a lot of information documented about how that world works, what are the terms? How does SBA work, et cetera? I ended up doing a webinar at search funder, which at the time, they said was the largest webinar they’ve ever done on tips for self-funded searchers from an investor, laying out some of what I was seeing from the market of tips and tricks.

That opened me up to the whole self-funded search ecosystem, and 7(a) loans and different approaches there. That was a lot of fun. The journey unraveled, as you can tell. As I was doing self-funded, I started meeting some traditional searchers, who had already raised and had really interesting deals that had small equity gaps. They would want my expertise generally, because it’d be related to software or government services, or just growing fast businesses. I did a few of those. That was fun. Then last, which I’ve been doing lately is I joke to my wife. I’ve never used the fact that my wife is from Spain as often as I have in the search community, because there is the Spain search mafia.

A lot of the search in Europe comes out of Spain, so I’ve ended up investing internationally as well, and it’s been really fun. Search is really just exploding across the globe, so invested in deals in Brazil and Korea, South Korea, in Hungary, et cetera. That’s been really cool to see the progression of search.

My wife is from Romania, and I talked with a searcher from Romania recently. That was an exciting moment, so I could see how that would be a nice leg into that community. Is there any particular reason that Spain has become the most popular, or is that just so happens where it became popular?

There’s two big business schools in Europe, where they teach it. IESE is the IE Business School in Spain. That’s the big reason, and INSEAD out of France, and so it’s really the IE business school that started it. There’s been a lot of searchers. I think it’s the third most populated country. I think it’s the US, Canada, then Spain. From talking to searchers, another interesting thing about international is every country is a little bit different on both the debt, but also the data.

Spain has an interesting thing where I think by public record, all the businesses have to file information on their business every year on their revenue, et cetera, which doesn’t exist in the U.S. There’s also a good playing field and data to invest in Spain, so you see more searchers there.

That’s fascinating. I didn’t know that. That’s good to know. As you’ve gone through search investing, how did you start to establish your own best practices as an investor?

One key part of the journey was early on, one of my good friends in D.C., a guy, Alex Mirrors, we started investing together, and his career path was one of these guys that makes you feel bad about your career. He’s like Harvard, McKinsey, Blackstone, left and joined the military for six years, and then Bain and Carlyle. He’s really got the private equity thinking. What I find I like about folks who’ve done private equity is there’s a methodology of looking at deals, of how you model deals, how you look to the characteristics of deals, how you model base case, upside and worst case.

I’ve learned a ton from working with him, looking at deals. I have the entrepreneur hat on, so I’ve been in this seat, know what it’s like to be an entrepreneur. I can see growth paths and moves, and then learning from him around how to look at businesses. That’s been a really good combination for me and partly him being a military vet. We’ve backplate. 25% of our deals have been military veterans, which is a cool part about this space, a lot of military veterans in this space. Even though I’m not a vet, which USA lets me know every year that Homeland Security does not count as a military, I do have a great appreciation for military service as working in civil service and Homeland Security.

Partly, what’s been fun is the more deals you see, the more you learn what you like. For me, on search, there’s really three buckets I look at. One is the team. I look at the team in a couple ways. One is the searcher or searchers. What’s their background? Have they run businesses before? How do they think about value creation? Have they managed people before P&Ls? What’s the team like under them? Sometimes on these search deals, what you find is you’re buying it from an owner, but maybe their brother is the number two employee, so you have two employees now with a key risk if they will stay, et cetera, so really trying to understand the team on the surface, but also the team underneath.

The second is really looking at the business. I think these checklists that are in the Harvard book or the Stanford study on great businesses, there’s a reason people use them. They’re great checklists, and I’ve tried to create my own versions. I usually end up going back to their checklists of just recurring revenue, low customer concentration, tailwinds in the industry. All really do matter, and I think part of the reason they matter so much is any business transition is tough. As someone who started a business from scratch, it takes a lot of will to get something going and alive, and handing it off to a new person is always going to be risky, so you want all those things going for them.

Then the last, basically, I look at the deal. What’s the deal of buying the company? What’s the price they’re paying? What’s the seller know? What are the terms? I look at what’s the structure for an investor, both from a levered and an unlevered return, and just putting those all together comes to a framework of approaching the search deal. It’s one of those things. You get better over time, just like I think searchers do… The first deal they look at, they might get a little deal heat, and everything looks good. The first time as an investor, you look at a search deal. You get excited, but by looking at a number of them, you start getting a sense of what’s okay, what’s good, and what’s great.

Absolutely. I know, in conversations with both you and Alex, that government services is an area that you’ve also focused a little bit of effort on. I’d be curious to hear what kind of businesses fall into that category, and what are some perhaps interesting tailwinds for government services.

We both really love government. A couple of things, I think, one part I like about it is a lot of people just hear the word government, and they want to run away. They think of long sales cycles and complaints with the government. I feel like almost that’s a note. Then really, government’s a huge part of the economy. I mean, I don’t have the stat in front of my mind, but federal state, local government, K-12 schools, it’s a really big sector with a lot of sub sectors into it. When I say I’m interested in government, that’s really a range.

It could be the classic. I think it’s in one of the search books about the mosquito repellent company that only sold to government. That’s taken a dirty services businesses, but a great customer base in government, and why government can be a great customer base is one, they’re sticky. They can be hard to get in, but they stay with you. Two, if you’re doing a good job, they’ll give you more work, so there’s great upsell opportunity. Three, they pay their bills, and they’ll go out of business, so selling to small businesses. They do go out of business or have problem with payment. Government pays the bills.

Then the last is they’ll tell their friends. In other sectors, if you do a great job for a client, say you’re doing a great job for Pepsi, Pepsi is not going to tell Coke that they’re using this great vendor. But in government, if you do a great job for the city of Seattle, they’ll tell their friends at King County in Washington, who will tell their friends of the state of Washington. I like those dynamics in government and across government. I’ve looked at and done a variety of deals, so I’ve done classic state local government software deals, where you’re selling software to state and local governments.

I’ve done a couple investment once, and Freedom of Information Act, which is a compliance law that agencies have to do. I’ve done a deal around transit. On the services side, I’ve looked at deals in the defense and aerospace space. I think those are very interesting. I’ve actually worked with and met a few searchers that are military vets and are looking in those sectors, sometimes their service disabled veterans looking to buy a service disabled veteran-based business. I think there’s some really interesting opportunities there as well.

What I love about it is it’s just such an interesting sector. It has some good tailwinds, and then you have all these mini sub segments within that keep it exciting. Just yesterday, I talked to someone who was looking at an MSP where K through 12 was a big part of the customer base. From now, so you wouldn’t think that’s a government business, but you dive in, and you’re like, “Okay, it’s got a lot of interesting elements from the customer’s side.”

That’s fascinating. Also, as search has become more popular, there’s more and more searchers these days, but there’s also more and more investors, especially individual investors, as we both have experienced a little bit of outreach from folks who are looking to get into investing in searchers, and want a little bit of advice. Do you think investing in self-funded searchers is for most people? Earlier, you mentioned that most people shouldn’t just become LPs in someone else’s fund, but is there a character or avatar of an individual who direct search fund investing might fit for?

I do get a lot of those calls too from investors trying to invest in the category. I think it goes a little bit about what you want to do and what you want to accomplish out of it, which can really vary. I think it’s pretty similar to investing in startups, where there’s a lot of advice around investing in startups. I would say if you’re from the outside, and you want to just invest in the category, you read the Stanford studies. You hear there’s great returns. You like the diversification from the public markets. I think, probably the best way to do it is to be an LP in a fund, to get some diversification. Any asset class like paying a GP to do it is usually worth it just in the same way it is for real estate and others.

If you’re looking to roll up your sleeves a little more, so some folks I talked to, they’re in it because they love small business. They’re looking to do something in addition to their day job where they’re a little bit more hands on. I’ve seen some investment where maybe they’ll partner with a college friend, or a co-worker, or someone really in a trusted circle, and invest in buying a small business. I think that’s a really interesting opportunity, so high trust, if that makes sense. I think that’s a really interesting, compelling opportunity. Obviously, more concentration with that approach, but I’ve seen that where two or three college friends, one of them goes in to be the CEO of the small business.

The other two are going to act as chairman. I think that’s a really interesting approach. Then I think there’s the approach of what do you do if you’re in the middle, which is kind of like, “Hey, I’m interested in self-funded search. How do I get involved writing some checks?” Like anything, I think a lot of the advice and say, like Jason Calacanis’ book about angel investing is a good one, where there’s a couple rules of thumb, which is one is it takes time to build really good deal flow. Usually, the stuff you see at the beginning, you’re seeing it for a reason, so taking the time to invest in learning the ecosystem.

I think Calacanis in his book says, “Try to build a diversified portfolio.” I think that makes sense here as well. The third, I think understanding the dynamics of you are in a self-funded search as an investor signing up for a few things. I wrote a post on search funder about this. SBA requires two months of your bank account as an investor in a deal. Most of these deals are getting K1s if they’re done as LLC, so you get K1s every year where you’re liable from a tax perspective for your proportion of the earnings. K1s are often sent after April 15, so you might mess up your taxes. I think just understanding what you’re signing up for, and I think there’s a lot of folks that do it well, and it’s worth doing.

But I think just understanding it will take some time, take some diversification. You are also sitting third on the debt stack, so you’re sitting behind SBA and a seller (inaudible) on a highly leveraged business. It could be a risky item, so make sure you’re doing your due diligence on the deal and business and investment. I think it’s an interesting opportunity, all the asset classes. Once again, I’d say, “Look at the barbell theory LP get access to the class.” I think it’s an asset class, like real estate, where it pays folks who have the network and spend the time to do it.

On the other side of the barbell, I think a very concentrated approach with highly people you trust. Partnering with one or two folks to go out and buy a business together is the other end of the barbell that I think are really interesting. I think in the middle making a number of bets and self-funded folks you don’t know super well, I think is doable, but I think you just have to spend the time and effort to do it well, just the same way of you don’t want to just step into angel investing in startups and do it. When you’re competing with pros, you don’t want to just step in without understanding the risk profiles around it.

Absolutely. If you think about constructing a portfolio of self-funded search deals, is there an optimum number of investments or deals if you’re going to write off your own balance sheet that you feel you need to get to at least this number to have optimum diversification in your portfolio, or what other ways have you found that if you’re constructing a portfolio from scratch, what are some guidelines you’ve come up with?

Generally, in a fund, they’re doing I think, it can range, but 20 investments in a fund would be a standard fun, dynamic diversification. That’s probably a ballpark here. I think you want diversification across years, so every year is a little bit different. That’s the time horizon. Like in any asset class, you want diversification. Over the years, probably want some diversification across types of industries as well. If I was only going to do three, I wouldn’t do three lawn care. I might want to try a couple different industries as well, and then across different types of searchers too might be an interesting way to do it.

What I found is there’s a range of searchers now, which is super interesting. You have folks right out of MBA, from classic search schools. You have folks mid career, some from those top MBAs, but some that just heard about it. Then you have a lot in between that maybe didn’t come from either of those classic pedigrees, but maybe they worked in private equity, and they saw folks doing deals and wanted to do a deal themselves, or investment banking, or came from… We see some real estate entrepreneurs moving in to SMB. I think there’s also some diversification across the different types of folks that are being searchers these days is pretty interesting.

Have you seen any commonalities across the search deals you’ve done that make them successful? Is there a character type, personality type background that helps her as an indicator perhaps of a higher likelihood of success?

There’s a couple things I like. One is entrepreneurship is a journey. It definitely is one of those things where one hour, you’re on the top of the world. The next hour, the world’s falling apart, and you’ve gone back and forth. I think this entrepreneurship is even more so. Searching for a deal is tough. The job of a searcher is basically an inside sales job. You gotta find data, cold email people, cold call folks, work with brokers. It’s got a glamorous title, but it’s a tough grind of a job. Then when you go on and run the business, it’s not necessarily the most glamorous business often, and hiring and firing and dealing with all the complications.

I look for folks that have grit is a good characteristic that can handle the ups and downs. I think folks that really know what this world is like is key to maybe they’ve worked for a company in the space or interned for a searcher, and have a less rosy picture of it, and say, “Hey, if this is what I’m signing up for, and I want it,” it’s like many of lawyers who want to quit their white collar job and open a restaurant, but you tell them go work in a restaurant for a month as the owner and come back. The same applies here.

Then I like a couple other ones, a mix of humility and confidence. It’s a weird combination, but humble enough for ask for advice and listen, learn, but also confident enough to aspire leadership within your team and your staff, the people you’re selling services to, et cetera.

Gotcha. That makes a lot of sense. Is there something I haven’t asked you that you’re dying to talk about?

What’s fun about taking a lot of phone calls is I talked to a lot of folks early in the journey, and they’re trying to understand what flavor of search is for them, and what they want to do. That’s a fun one. What you see these days is there’s probably three or four main categories of search, and I think you need to understand what you’re trying to get out of it, and where your skill set lies. The classic traditional search, I think, the great pro about it is you’re surrounding yourself. Usually, there’s 10 to 14 investors, and you really get to have a world class caliber of investor that you normally wouldn’t get around in the same table.

You’re also getting… While it’s a smaller piece of a bigger pie, you’re also running a bigger pie. Usually, that means you’re a CEO of a 50-person company or 100-person company, and you have levers that you just don’t when you have a smaller company to play with. You also have more backers around you. When you’re putting your IOIs, and you have the letters that make you look stronger in a community around. I think the other approach, which is growing now is this stellarator concept. Some folks that look at traditional and like that model also say, “Hey, I want actually a little more hands-on help, so I don’t want to build out my deal sourcing for the first time, or figure out how to hire interns for the first time.”

Now, there’s three or four different accelerators like NextGen Growth and Search Fund Accelerator, where they provide you that infrastructure. Some folks love that, “Hey, I could plop into this infrastructure.” I actually have a cohort that has that fun cohort vibe. You’re all on the same team. I think for the right person, that’s a great approach. Other folks look at that and say, “Hey, I got into this because I want to be my own boss. I don’t love the idea of having one investor who owns the majority of the economics who can yes or no on my deal. That doesn’t sound what I want to do.”

Then you see self-funded search. I think self-funded searchers that the common question always is, “Should I go full time or part time on this?” Self-funded search, you are not getting paid a salary. I did not mention the first two, huge pieces. You’re paid a salary to search, which when I first heard about it, I was like, “What a great deal.” You get to search to buy a business. You get paid to do it. It sounds amazing, so the con of self-funded search is you’re not paid to do it. I found a very common question from self-funded searchers is whether I can do it part time.

I will never tell anyone to quit their job. That’s such a personal decision based on lifestyle and where they are, but I will say it’s quite hard to do it part time, just owners want to have calls during the day during work, the amount of hours to even do the work. It’s just really hard to do it part time, and so I’d say the majority of the cell phone researchers that succeed do it full time. That’s another decision. The self-funded searchers, I often find they’re doing it because they really, really want to be their own boss. They want to own a large majority of the economics, and they want to do it themselves and have strong control.

The beauty of that is you get to decide what you want to do. You can target any industry. You can set it up any different way you want. The con is what I found on self-funded searchers is there’s less of a community of investors helping you, which can be a little bit tougher. Then I found sometimes self-funded searchers, they may not have seen as many deals, and they don’t have folks surrounding them, giving them the reality check of, “Hey, that’s a bad deal. You shouldn’t do it,” which in traditional accelerator, there’s more guardrails around it. I always try to tell folks there’s no right way.

Each model has its own pros and cons. The best thing for, I think, any searcher is what most people do in this community, they go try to talk to 20 to 30 searchers, explore their different models, figure out what resonates best with them, both personally, but also in their personal situation at the time. It’s not even just usually one person. Most folks maybe have a significant other or a family, and so they’re trying to make that decision in a broader context. I think that’s important to realize and think through.

Absolutely. What class would you teach in college, if you could teach about any subject you wanted?

I’ve tried to do this a couple times. I never mastered it. I feel like it’d be a good business if anyone want to do it. I would love to basically teach a boot camp on communications for college students. This sounds really silly, but I found in life, I probably spent a third of my work career on email. I’ve never been trained on email, never done a class on email, but I feel like I built just tips on writing great emails, how to deal with subject line headers. I’m big in spacing, line spacing, and bullets. I’m really just shocked the amount of time people spent on these white collar activities without ever being trained or taught.

To me, they’re like, “It’s email.” The second one is conference call etiquette. Conference calls are now decreasing into Zoom calls, but there’s still skill set for, “Hey, if you’re going to spend 25% of your career on conference calls or video calls, you should probably get some tips on how to run a great meeting, how to take notes, how to prep folks, et cetera.” That’s where I’d spend time just really teaching. Look at, if we’re talking college graduates that go into white collar work, where are the folks? Where do you spend the most time?

I think it’s almost like a weekend three-day boot camp et cetera from the career services class. It’s funny, I’ve taught this one-hour sessions, a version of it, a few times. I’m always surprised how it’s the first time anyone’s ever almost even talked about this subjects, where people will come to me and they say, “Well, you can’t be good or bad at email.” Some people prefer extra why. I disagree. I think there’s a good way and a bad way to do these things.

How do you be bad at email?

Rule number one, too long. Assume people skim email is number one. The worst emails are no line breaks and super long. That’s rule number one. Rule number two is putting what you’re doing in the subject line. What are you trying to get out of the email? I feel like the military and a couple other industries do this well, where they’ll actually have adjectives like knee decision and brackets and then the name of the email. It’s real simple. If you take the assumption that people skim email, the subject line should be clear what you want out of it. The email should be short and clear. It’s surprising how many emails aren’t that way.

Excellent. Any tips for conference calls?

Put everyone on mute. It’s like a one-on-one. Conference call in Zooms are pretty simple, which is just have an agenda. Send it out. Show up early. If you’re running the conference call, you should be there two minutes early. I’ve been trying to teach my son this that on time is late, and the basics of understanding how to mute everyone in the beginning. I think for Zoom and others, setting a culture around the expectation around video, I think, is an important nuance where when half people are on or half off, I think, is not the tone. I think… Sometimes, there’s times where it’s very valid not to use video, but I think setting clear expectations, so everyone’s on the same page.

Then I think last, now that we’re going back into… Vaccines are coming. We might start getting to more of these hybrid environments. I think, really understanding the rules of when you have four people in a room on a conference call, and then eight remotely, how do you make sure it’s compelling for all folks there? There’s a lot of tricks I’ve seen there, so it just doesn’t end up being like just the three people in the room talking, and the eight people not in the room feel like they’re getting left out.

Those are excellent. What’s the belief you used to hold strongly that you’ve changed your mind on?

I’m a startup guy from this base, so I think the main thing that defines me and even some of the stuff I’ve done, I didn’t talk about, I created a nonprofit called Young Government Leaders. I started a number of groups in college. I’ve just always loved taking an idea from something than nothing, and really growing. I was a big believer in the Zuckerberg. Move fast and break things, I think, was very core to who I was early on in my career of a person of action. The idea is just to get going. Break some things, learn and iterate.

Then, I think, over time, I’ve gone to a more amended version of that, which is move slow to move fast, if you’ve ever heard that line. Move carefully and fix things is a version of the Zuckerberg line. I found that by spending more time upfront, to move slow up front really helps you speed up faster. I think that’s been a change of my mind is trying to slow down, and get more buying up front, set things in place, and then sprint. That’s been a change of mind over time.

What’s the best business you’ve ever seen?

The best part of a search as you see a lot of businesses. I feel like my first business that got acquired is called GovLoop. It got acquired by Gov Delivery. I told my boss I wanted to get an MBA at the job. Basically like, “Put me on the board. I want to learn from you.” I really got an MBA from him along the journey. A great guy, Scott Burns in Minnesota, who now runs a great startup there. Search is the same a little bit. You get to see all these different industries, where one day, you’re looking at the MSP business. The next day, you’re looking at a software business. One day, you’re looking at lawn care and all sorts.

A couple ones that I look at are in software, there’s a rule 40. This is a classic rule you hear in software business, which is revenue growth, plus EBITDA percentage, and so you want to be over 40. One of my favorite businesses I invested in early on in search was a Brazilian ERP software business. It’s funny, ERP for ISP, so internet service providers. It was this great business. It was like… I think it was an 85 on the rule 40. It was growing 35% year over year, 50% EBITDA margins, great market. It was that hidden gem. I like these businesses that are not in the major city.

It was not Rio, Sao Paulo. It’s a smaller tier city, and then had just great tailwind with the customer base. I think net retention was 118%, which I talked about before. If you cornered me and said, “Hey, what do I care about a software business,” it would be rule 40 and net retention. It was 80, and then 118. The other ones that I like I always had from the public market. I’ve been a big Twilio user early on in multiple of my businesses. When you talk about net retention, which once again, if you think about a lot of searches is highly recurring. If you wake up, don’t sell another customer the whole year.

How many dollars will you have at the end of the year? $100, if you wake up 110 without selling to another customer, that sounds amazing. Twilio when IPOed was 157% net retention. You don’t have to sell another customer, and you go 57%. I think they were like… When they hit two billion AR, which is insane, the size and scope. As someone who’s run a eight-and-a-half million dollar company, it gets harder the bigger you are. I think there are 137% in that retention then. I mean, there’s a reason that that company, I think, has gone from a $3 billion market cap to 100 billion.

Then the last one now, I just looked at… I think we’re in April of###-###-#### Using that rule of thumb, I looked at Coinbase IPL. They were, I think, a 180 on a rule 40. They’re growing 130% year over year, 50% EBITDA margins. That one’s less recurring, so I don’t think it was my best business, but sometimes you see these businesses, and you’re like, “That’s insane.” You’re growing that fast. That’s such a EBITDA profile.

That’s fantastic. These are really fun businesses to talk about. I love hearing all these different stories from your time and in software and SMBs. Now, thanks for sharing your time today. I’ve really appreciated learning a little bit from you. I always enjoy talking with you and Alex about search funds as well, so looking forward to our next chat.

Awesome. Feel free to reach out. I love talking to searchers. I’m just Steve Ressler on Twitter. I try to send out a monthly newsletter on search, which you can find from my Twitter as well. Thanks, Alex, for doing what you’re doing in the community. It’s a great group of folks, and I love this podcast. I learn something new every week.

Well, thank you very much. I also read your newsletter, and I’ve definitely enjoyed reading that through. Thanks for doing that as well.

Awesome. Sounds good.