Roundtable: The rise of entrepreneurship through acquisition
Byline: Stephen Emerson, Managing Editor.
Strong investor returns, vendor appeal and interested searchers are the key factors driving the growth of the search fund model
Innovation is the driving force behind dealmaking, with new thinking needed to ensure returns for investors continue to grow and that more attractive exit options for company founders become available.
Search funds and Entrepreneurship Through Acquisition (ETA) are gaining traction due to the return they provide for investors, the succession options they provide for vendors and the number of searchers attracted to the model.
The intricacies of this topic were discussed at a roundtable held in partnership with The Business Magazine, debt funders Shawbrook and leading accountancy and advisory firm Gerald Edelman at their London offices.
Attendees included searchers looking for companies to acquire, searchers that have completed ETA transactions, investors, debt funders and company brokers.
ROUNDTABLE PARTICIPANTS
Moderator: Stephen Emerson, Managing Editor, The Business Magazine
- Ola Malomo, Founder, 11 Minutes
- Alexander De-Sowah, CEO, Black-Scholes Partners
- Ben Marcilhacy, Founder, Dramont Partners
- Tasleem Rhemu, Director, Epilogue Capital Partners
- Tobias Raeber, Founder and Managing Director, ETApreneur.com
- Jo Cockburn, Investment Director, Ethos Partners LLP
- Sandy Farmer, Co-Founder and Partner, Ethos Partners LLP
- Carl Lundberg, CEO, Gerald Edelman
- Florian Wilisch, General Manager, Hamburg Ventures
- Frederik de Coninck-Smith, Owner and Managing Director, Out n About
- Michael McDonald, Director, Ryton Equity
- Viren Lala, Principal, Sentinel Capital
- Adam Ginty, Marketing Business Partner, Shawbrook
- John Hunter, Director, Shawbrook
- John Palmer, Senior Director, Shawbrook
- Rob Edwards, Regional Director, Turner Butler
Jo Cockburn, Investment Director at Ethos Partners, said ETA presented an attractive model for business owners looking for an exit. He said: “What distinguishes ETA, be it self-funded or traditional, is that from an investor viewpoint, they are buying a steady business at a reasonable price and injecting management talent that is, albeit not super experienced, of a calibre that can outperform the average manager of an SME.”
Search funds originated in the United States and are growing in popularity in Europe. The traditional model sees an entrepreneur, who has typically achieved an MBA, gain funding from investors to search for a company and then secure investment to help fund the acquisition. The entrepreneur may supply some of the funding themselves, alongside the investor, or the buy-out may be leveraged with the assistance of a lender.
Variations of the model have emerged including self-funded search, which sees an entrepreneur fund their own search, identify a company and bring in investors later.
Self-funded searchers tend to offer investors less equity in the company as they have financed their own search process.
A typical exit for a searcher and investor is between three and seven years.
Carl Lundberg, CEO of accountancy firm Gerald Edelman, said: “We always have to be careful about the terminology used because having been born out of academia, some people have a very rigid view. You’ve got some self-funded searchers who may say that they are a search fund, but traditionalists would probably argue that they didn’t have a search fund because they didn’t raise search capital.
“Although I’m sure most people agree, all of it is Entrepreneurship Through Acquisition.”
Selecting companies for acquisition
Many entrepreneurs employ interns to carry out research work alongside attending trade shows, contacting potential sellers, working with brokers and speaking to business owners in their target niche.
Of core concern to searchers around the table was the quality of the company, its customer base and niche.
Searcher Tasleem Rhemu, Director of Epilogue Capital Partners, is looking particularly at the fertility sector.
She said: “Fertility has good quality revenues as you are helping people on a journey to conceive a child. Women in their early 20s don’t want to have a family early on and are harvesting their eggs. The model is changing, not just from a two to five-year journey but to a 20-year journey where they are harvesting their own eggs and waiting twenty years until they go and have children.”
Fellow searcher Ola Malomo, founder of 11 Minutes, said he was focused on small and midsize businesses in the compliance and payments sector.
He said: “I am interested in companies where there is a pure compliance angle or a payments angle. I’m very focused on a specific niche that fits in well with my background.”
On the investment side, cash flow, profit margins and the robustness of the business were key considerations for investors considering an acquisition.
Investor Viren Lala, Principal at Sentinel Capital, said: “You have to look at the risk from a high-level perspective, look at the people, processes, systems and understand where this business is going to potentially be struggling and how that can be navigated.”
On the lending side, John Palmer, Senior Director at Shawbrook Bank, said that ETA transactions were viewed as any other approach for leveraged finance.
He said: “Key to our assessment is considering whether the target company meets the characteristics of a business that is well suited to leverage finance? This would include an assessment of whether it generates sustainable and recurring revenue streams and a healthy EBITDA margin, which then converts to free cash flow readily.
“Are there strong underlying growth factors in the market which allows the company to do that year in and year out?”
Credibility of the searcher
Searchers face the challenge of finding investment partners, if they are following the traditional mode, or bringing investors on board later.
Sandy Farmer, Co-Founder and Partner at Ethos Partners, said reputation was key for searchers.
He said: “To get past that first gate is a challenge for many searchers. The successful ones we’ve seen are those who tend to have a bit more reputational power in their particular sector.
“Those who are in their 40s or 50s have credibility because they’ve worked at
a senior level in a particular industry or partnered with investors before and have that repeat game reputation in the market.”
Carl Lundberg of Gerald Edelman said one of the biggest obstacles facing searchers was convincing the intermediary. which could be a broker or a person acting on behalf of target companies, that they are a credible option.
He said: “The intermediary cares, first and foremost, about whether the money’s there, whether you’re actually a trusted buyer or someone who is trying to patch things together without capital.
“The initial hurdle is to convince the intermediaries that you are credible if you don’t have reputation in the market for delivering transactions.”
Michael McDonald, Director at Ryton Equity, said searchers can advance their credibility with brokers by partnering with established funds and having signed letters of funding commitment from investors.
He said: “Partnering with established serial investors can help buy credibility with brokers. Leveraging your unique professional experiences is also key.”
Searcher Florian Wilisch of Hamburg Ventures added that the story that searchers tell will help attract the attention of investors and sellers.
He said: “The story that you tell helps with your credibility. I don’t have an MBA or come from a finance background but I spent 10 years working at Apple and this seems to open a lot of doors for me.”
What banks look for in a searcher
Bank finance is often crucial to getting a deal over the line, so what do lenders look for from investors, searchers and the company they are looking to acquire?
John Palmer, Senior Director at Shawbrook Bank said: “We’re lending to both the fundamental underlying business and the incoming management team.”
Under the traditional ETA model, an MBA is viewed as a key component of a successful search fund vehicle, yet the roundtable was unconvinced that it was entirely necessary.
Florian Wilisch said having an MBA did add value, but it was more important that searchers could demonstrate that they had the acumen to run a business.
He said: “An MBA gives you education. It teaches you about how to do things in business. It suits people that have not learned that before in their career.
“When I was in my pre-search phase it was all about education. Specifically, I put aside three months where I was just learning. I was learning the ropes. I was learning about finance and business functions.
“I don’t think you need an MBA, but I do think that you need to be realistic about whether you have the know-how and are able to run a business or not.”
Tasleem Rhemu of Epilogue Capital Partners said that an MBA combined with career experience adds to the background story of a searcher.
She said: “Saying that I have an MBA can help to elevate my storytelling. However, it’s not just saying that I have an MBA, it is explaining how it helps me in my journey. The experience you have had in your career can also help with this and you can link it to each part of the story of how you would grow the business.”
Vendors
Finding a company is only part of the process. The hardest part for a searcher arises when closing the transaction.
Rob Edwards, Regional Director at broker Turner Butler said people selling their businesses are attracted to the succession that an ETA model provides.
He said: “Some vendors may not take kindly to someone coming in and telling them how they should run their business. The key appeal to a genuine retiring vendor, however, can be the succession part which can make the transaction attractive.”
“The human relationship between the two matters more in getting the capital structure agreed probably than almost anything else. Because you are telling someone they’ve got to wait for their money.”
Sellers place value on passion and commitment from buyers, he added. “They do look kindly upon people who have passion for what they are going into.
“If you are a searcher coming into this with skin in the game, that’s emotional as well as financial. They do look kindly on those things, on those attributes.”
Searcher Frederik de Coninck-Smith, Owner and Managing Director, of pushchair retailer Out n About, added that searchers were often faced with long searches until they come across a buyer that is open to ETA and prepared to wait, in some cases, for some or all of their pay out.
He said: “You’ll speak to hundreds of business owners that want to sell and don’t fit that model so you have to find the ones that do like the model and think it will work for them.
“The vendor will have worked hard on their business for years and they will want to get some cash and go and do something else with their life.”
Investors
Taking charge of a business and delivering a return for investors is never easy.
What appeals to investors about the ETA model is the searcher’s role in building up a relationship with the key players in the business before acquisition.
With the searcher playing such a pivotal role, what do investors look for in the person that will play a large part in determining their returns?
Michael McDonald of Ryton Equity said self-awareness was key, as was a readiness for the tough journey ahead of them and the ability to make business-defining decisions.
He said: “I find one of the hardest things to assess is their ability to act as a principal commercial decision maker. You can find someone who’s got a fantastic professional and academic background, they can articulate very clearly why they want to do this, but it is not always clear that they will be able to fulfill the role of the CEO. Some people struggle with the pressure of decision making in times of uncertainty while others flourish.”
Sandy Farmer of Ethos Partners echoed this point about resilience and preparedness for taking on a business.
He said: “A lot of our interactions with searchers focus on their motivations and behaviours. We look at how well they have thought about the journey as it is much closer to being an entrepreneur than being a general manager in a small business. We also look at how they demonstrated grit and resilience because you will come up against a lot of things you haven’t done before.”
Banks also look for the above qualities but, according to Shawbrook, lenders look to see evidence of an understanding of the business and the sector that it operates in.
John Palmer of Shawbrook said: “We look at whether the people that are buying this company have sound knowledge of the sector, understand the business and have a good grasp of what they are about to take on.
“Management Buy Ins (MBIs) have fallen out of favour recently in the UK. We had typically avoided them because you haven’t got a management team that is already in the business, that are running it and understand it, as well as buy-in teams having limited personal equity to invest alongside debt.
“We have seen a high calibre of searchers that have a better understanding of what makes the business tick, and the search fund provides additional equity to better balance the risk between all parties”
Shawbrook’s John Hunter added that they looked closely at the investor profile of searchers with reputation a key factor.
He added: “With a lot of transactions we often know the investors and that can provide a level of comfort as we will have worked with them on the journey. If we can see that there’s some stronger institutional investors in there that we’ve seen and worked with before, that does provide a level of comfort.”
ETA as an asset class
The ETA model appeals to investors as it taps into a gap in the market: companies with an EBITDA between £1 million and £5 million, not targeted by private equity and large institutional investors.
Jo Cockburn of Ethos Partners said that ETA did perform better against other investments.
He said: “I think it comfortably outperforms other alternative asset classes, but it is a small entrepreneurial niche within the overall asset landscape. It is, in my opinion, probably never going to attract large amounts of institutional capital as the volumes are far too small.
“I think it’s very well suited to investors who are deploying private capital, family capital and individually-made wealth.”
Michael McDonald added that some investors prefer the traditional search model as they get a better view of the companies involved and can assess if the searcher is up to the job.
“In a self-funding acquisition, as an investor, often you meet the person – perhaps for a couple of weeks or a couple of months, and they already have the specific acquisition.”
Bank viewpoint
Banks play a pivotal role in the ETA process. Investor and searcher capital will often be used to leverage the buyout where lenders will typically look for a 50/50 split between debt and equity.
Banks will normally be approached by an advisor and will work with the search fund vehicle to propose a funding structure for the transaction.
The process, which involves due diligence and getting credit approval at the bank, will normally take between six weeks and three months.
Shawbrook’s John Palmer said that when coming to a decision the bank puts weighting on the balance of shared risk involved in the transaction.
He said: “Do we feel that everybody’s taking a fair share of risk? If vendors are staying in the business, are they suitably motivated? Is the searcher putting in individual equity? What you never want to have as a bank is a situation where, everybody else is able to walk away from the table without sharing in the risk.”
Shawbrook also say their lending decision is based on a long-term outlook which goes beyond the initial acquisition.
Shawbrook’s John Hunter said: “We don’t want to just provide funding for the initial buy-ins, we want to fund future growth and further acquisitions. When we’re assessing the credit and when we’re talking to searchers, it’s not just about, here’s the five-million-pound so you can buy this business. Here’s five million, which includes a committed line for acquisitions.”
This close banking relationship can also assist companies when problems arise within the business.
Shawbrook’s John Palmer emphasised the importance of early intervention.
He said: “Less experienced management teams, where there is not a robust finance function, tend to approach their lenders later in the day to say that there is a problem. The problem will then have ballooned into something which is very difficult to solve and our options as a lender will have narrowed considerably.
“In most cases early intervention will allow the bank time to find a solution to support the business through a difficult patch.”
Strong finance function
Having a strong finance function is seen by Shawbrook as vital in leveraged finance.
John Hunter said: “One of the key areas that we have identified as a bank, not just in search deals, but possibly every leveraged transaction, is that weak finance functions, or non-existent finance management functions, cause a lot of problems.
“A lot of management teams really undervalue what a CFO can bring to a business. They are not someone who is there just to tick a box, they need to be there making strategic decisions, improving the financial processes and leading those conversations with the funders. This means the CEO is able to focus on the operations.”
The roundtable concluded with agreement that with its continued strong investment performance, the ETA model was well positioned to exploit the market space left untouched by private equity houses.
