WHAT HYPOTHESES DO YOU HAVE ABOUT THE CURRENT ECONOMIC ENVIRONMENT?
In my conversations with searchers and investors, I've discussed some interesting perspectives on how the economy (and possible outcomes of COVID 19) could affect the search environment. I would love to hear additional thoughts from this community.
In particular, what are your hypotheses on...
* Search funds launched (continue to grow in popularity in the near term?)
* Search fund investment (contract or expand?)
* Lower MM PE/M&A activity (increase or slow down?)
* Overall acquisition valuations/multiples (generally increase or decrease?)
* Other high impact trends (e.g., industries to watch, unique search strategies that will prove successful, characteristics of businesses that will command a 'COVID' premium or discount?)
Would love thoughts on any/all of the above. If interested, I'm also happy to share my synthesis based on the conversations I've had so far (feel free to DM). Thanks!
- Near term might be a dip, but overall growth trajectory won't be to heavily affected (still growing)
- Investment will absolutely expand
- Multiples will increase naturally as more money is deployed in this space
- Unfortunately the politics surrounding the pandemic (i.e. what businesses were deemed essential vs what were not) will no doubt affect investment decisions going forward. My estimation is that businesses in the government contracting space will gain premiums because of their ability to stay viable during COVID
- The COVID-19 recession is going result in the formation of more search funds than would have occurred pre-crisis. We’re entering an environment over the next year where economic uncertainty prompts traditional MBA graduate employers to pull back hiring (see the following article from today’s WSJ: https://www.wsj.com/articles/m-b-a-s-are-usually-swimming-in-job-offers-by-now-not-this-year[redacted]?mod=hp_lista_pos5), so over the next 12 months fewer MBA grads than usual will have to weigh the opportunity cost of turning down a position at Goldman or Bain against starting a search fund. This means even more fierce competition for deals among searchers.
- I expect search fund investment to expand as the cost of capital remains low for the foreseeable future. As the NASDAQ continues to boom I think more high net worth investors will be open to taking some chips off the table and diversifying their portfolios partially away from public equities – I say this because the investors who I have spoken seem to feel nervous about the market’s ability to sustain last quarter’s performance in the face of continued economic uncertainty.
- Lower MM PE activity will increase as we get closer to a vaccine and the PE world adapts to work from home as the new normal. In my industry, I’ve seen a material uptick in lower MM deals come across my desk over the past two months after a virtual freeze five months ago.
- Multiples will increase as more searchers (along with more investor dollars) case the same deals.
I’m interested to hear your thoughts – let me know if you disagree with any of my assessments!
Rob
The only think I might question would be your first point: I could certainly see a lot of MBAs 'defaulting' to search funds given the lack of jobs. On the other hand, I could also see a lot of MBAs foregoing the more 'risky' search fund route in favor of a stable job given the uncertain economic climate. Regardless, I definitely agree that there will be a lot more investment in the space given the low interest rate/cost of capital, which will boost multiples, especially for 'great' businesses (e.g., software services businesses w/ recurring revenue model in fast growth industries).
Given this, I wonder how searchers can 'differentiate' themselves to be successful in the increasingly competitive environment? I see three potential ways:
1) Finding a proprietary deal, based on cultivating relationships
2) Focus on business acquisitions in an 'underrepresented' sector (e.g., B2C)
3) Unique 'marketing' techniques to appeal to business owners in unique ways.
Any thoughts?
That being said, we are still in the midst of the situation, but there is also a chance that this is being accepted as the new normal. Since economic support from the government is now tapering off, we will likely see the businesses that can survive independently of that.
I know my thoughts do not directly touch on your questions, but there are still too many unknowns and I think too much faith being put in a vaccine (just look at the challenges the global supply chain is facing keeping up with what's needed now)..
But I agree about your point on opportunities that may be present underrepresented sectors compared to the standard B2B services. I imagine the more unappealing the business, the greater the potential opportunity. But the ETA ecosystem will likely have to become more accepting of these sorts of deals before we see a lot of them take off.
1) An effective vaccine will be developed before the end of the year
2) The vaccine can be scaled (i.e., produced and distributed) quickly (e.g., on the order of months)
3) Economic behavior (among both individual consumers and businesses) will respond quickly in reaction
I agree with you--I'm not sure these collectively are reasonable assumptions (though I'm no expert).
My big question: If we assume that recovery will be tepid, and take 1+ years, how will that affect the search fund ecosystem? In particular, what industries might be undervalued now or poised for high growth?
My gut reaction:
+ Travel & hospitality (probably the hardest hit right now, but has a high probability of recovery/growth over the next few years)
+ Services businesses in hard-hit industry verticals (e.g., restaurants, bars, concert venues etc.)
+ Technology businesses for 'low-maturity' industries (e.g., education, healthcare, construction) to take advantage of permanent trends resulting from COVID
+ Lifestyle businesses (e.g., recreational substances, alcohol)
+ Direct-to-consumer healthcare (e.g., to take advantage of the growing healthcare needs resulting from COVID)
Thoughts?
Surviving main street businesses, like the underrepresented B2C ones that you previously mentioned, may also present some good opportunities to searchers who can manage or adapt to working in that sort of field.
Others in healthcare were also testing out the market to see what sort of premium they could get for being in the 'right' industry but there was not a strong indication that they would sell. Its a small sample set but interesting feedback.