Mineola Search Partners is a firm that invests in Search Funds, the entrepreneurs who run them, and the companies that they acquire.
Prior to Mineola, Steve was the CEO of Microdea, a document management and workflow automation software company...
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Ronald Skelton 0:06
Hello, and welcome to the how to exit podcast where we introduce you to a world of small to medium business acquisitions and mergers. We interview business owners, industry leaders, authors, mentors and other influencers with the sole intent to share with you what it looks like to buy or sell a business. Let's get rolling.
Hello, and welcome to the out exit Podcast. I'm Ronald Skelton, your host, and today I'm here with Steve Divitkos. He's the founder of Mineola Search Partners, a firm that invests in search funds, the entrepreneurs are random, and the companies they acquire. Thank you for being on the show Steve. Man, I appreciate you being here.
Steve Divitkos 0:49
Yeah, thanks for having me.
Ronald Skelton 0:51
Cool. Let's just get started. Like I know you're, you're an entrepreneur before you got into what you're doing now. So let's do your origin story. Tell us how you got started into, into what you're doing now.
Steve Divitkos 1:01
Yeah, I'm an investor in acquisition entrepreneurs now. But my background is being an acquisition entrepreneur myself. So coming straight out of undergrad, I worked in the private equity business for a couple of years, investing in much larger companies that then certainly now focused on.
After doing that for a couple of years, I knew I wanted to do something entrepreneurial but I wasn't sure exactly what format will take. So, I went off to business school for two years trying to figure that out. When I was there, I learned about this thing called the search fund which, which we can talk more about. And it was a way for a single entrepreneur to search for, acquire and then subsequently operate a single privately held business. And, the more I learned about search funds and acquisitions entrepreneurship more broadly, the more it struck me as a really interesting way to effectively connect where I had been as an investor, and where I wanted to be as a CEO and entrepreneur, and business builder. And the prospect of buying my way into an entrepreneurial career had never even really struck me as possible before. So almost immediately, the idea resonated.
In my second year of business school, I decided to raise a formal search fund from a number of investors across North America. And then I you know, shortly after graduation, formally commenced my search. So I searched for about 18 months and purchased a software company.
In late 2013, the software company was co-founded by a father and son combination. They had been running the business since the mid-90s. So at that point for about 20 years or so. And the father specifically was in his early 70s and was naturally looking to transition to other phases of his life. And it was really important to them. They were seeking liquidity for their business for a couple of years, but never quite found the right fit. They didn't like the idea of selling to a strategic buyer. Because, you know, from an emotional perspective, which is very understandable, you know, they didn't want their business to effectively be swallowed up and become unrecognizable only a few years after the acquisition, nor were they particularly excited about selling to private equity, with, with all of the things that often tend to come with those types of acquisitions. So I kind of positioned myself, you know, in a soundbite as a succession plan, looking for a single business to succeed. And I think that, that kind of resonated with them. So, long story short, I bought the business from them in late 2013, ran it for seven years as CEO, and then exited in late 2020. Since then, I've become an investor in search funds and acquisition entrepreneurship more broadly. So now I'm investing in small and medium-sized businesses across North America, generally speaking, you know, somewhere in the neighborhood of five to $30 million in revenue. Somewhere in the neighborhood of one to $5 million of EBITDA. Typically, around 40 employees or so with but there's quite a, quite a large variation around that. And very frequently with entrepreneurs who are a little bit on the younger side, a little bit on the less experienced side, but similar to me 10 years ago, are looking to effectively acquire their way into an entrepreneurial career.
Ronald Skelton 4:29
Awesome. Now these entrepreneurs that are, you know, they're buying a business as opposed to getting out of college and going straight into a job. Does your firm providing the any type of guidance, mentoring assistance in making sure that it runs, runs well?
Steve Divitkos 4:48
Yeah, all the above. I mean, I think my position as an investor is directly informed by my DNA as CEO and as someone who has actually been through everything stage of this. So, I know how lonely the search process can be. I know how frustrating it can be. I know what it feels like to never feel like you're making progress. I know what it feels like to get laughed out of the room when talking to sellers who never think that you can run their business as well as they can. I know a closing a transaction feels like by yourself that would ordinarily be done by like a four person deal team at a private equity firm, you know, and of course, being a CEO is just an experience that nobody understands unless you've done it before. And so I tend to work with acquisition entrepreneurs who are doing all of this for the first time. And as someone who has actually sat in that seat before, for about a decade, you know, my focus is on making their journey easier than mine was and providing them with some of the guidance that I did get that was incredibly helpful. And just as importantly, trying to provide them with the guidance that maybe I didn't get, and maybe I wish that I got. And mentorship is a huge part of, of the search fund vehicle. In fact, it is a cornerstone of it. And there's a lot of great investors that have preceded me, and I'm just looking to just contribute to the community in any way that I can.
Ronald Skelton 6:09
That's awesome. The, what keep you in the phrase search fund. And, you know, I know what I went through my master's degree program back, I think I graduated in what 2007? I'd never heard of it. And so I just thought it was one of the maybe the school I went to or whatever. We were talking about this earlier at another meeting you and I had. And I guess this phrase, or the whole thing of a search fund, is a fairly recent thing. So what is the search fund? And, and kind of tell us a little bit about what that is?
Steve Divitkos 6:43
Sure, so maybe just to back up a little bit, the concept of a single entrepreneur looking to buy a business and then subsequently run that business? I mean, that's been around forever. right? Right, right. What a search fund is, is effectively like a more formalized structure to frame that endeavor. So as I mentioned, a search fund refers to a vehicle where a entrepreneur, often in somewhere in their 20s or 30s, raises a pool of capital to help him or her search for a company to acquire and then ultimately become the CEO of an operate moving forward. So in a search fund, the entrepreneur raises money in two rounds, the first round is pretty small. So they raise a couple 100,000 bucks to fund their two year search for a business. Usually that money goes towards paying their salary, office space travel, etc. And so investors like me invest in that stage. What investors like me get in return for that is the opportunity to participate in financing round number two. Financing round number two is when the entrepreneur has actually identified the company in question that they wish to invest in. And we help them write the check for that company. And the formalized vehicle of search funds have actually been around for maybe quite a bit longer than most would think. They started in 1985. And it came out of both Harvard and Stanford's Graduate School of Business. I think the first search fund was in the mid 80s. Since then, about 530 search funds have been raised. In the early days, they came out of mostly schools like Harvard, Stanford and Wharton. In the decades that have elapsed since then there's a much wider range of schools, a much wider range of backgrounds of the entrepreneurs themselves. And again, this is an entrepreneur looking to raise capital to help him or her buy a business and then become the CEO of that business moving forward.
Ronald Skelton 8:43
Let's just jump into kind of like, what is the search fund process? You, you raise around, you know, like you said that the first raise is to pay a salary. So you have a living, you know, some living money, and travel money to go do the search. Do you help with the search criteria, like showing the entrepreneur, how to pre-qualify a business and what they, you know, help them decide what they should be looking for? Is that all on them?
Steve Divitkos 9:11
That's a combination of both. I mean, the entrepreneur, him or herself, is effectively free to pursue targets in any industry that they choose. But the role of the investor plays is effectively to be helpful in any way that they possibly can be. So very, very tactically, as I learned while searching for my own business, there's a lot of tactical, just stuff that needs to happen. So it could be as tactical as you know. What technology stack do I use? How frequently do I reach out to sellers? What's the email automation engine that I should use? What CRM system should I invest in? It can be as tactical as that and very frequently less tactical advice would be well, what's a good business look like? What does a bad business look like? What about a good industry or a bad industry? How do I structure certain deals? How do I make sure that the seller still keeps skin in the game? What mix of equity and debt should I use to finance this acquisition? To what extent do we identify key person risk in the seller? And how do we structure around that? So as your listeners are likely to appreciate, there are about 1000 variables that one must consider when searching for an acquiring company. And as a result, there are about 1000 different ways that experienced investors can help them along that journey. I would say that search funds as an asset class tend to target, but not always, particular types of businesses in particular types of industries. So generally, from a size standpoint, again, there are exceptions to this. But speaking broadly, somewhere in the neighborhood of five to $30 million in revenue, maybe an average would be 7 to 10, something like that. somewhere in the neighborhood of 1 to $5 million of EBITDA, again, an average might be around two or so. Almost always owner succession. So the founder CEO is looking to exit the business in some orderly way over an agreed upon period of time. The industries tend to be more service and technology oriented. They tend to be more frequently B2B than B2C. They tend to be in asset light types of businesses that don't require a lot of capital to scale. And industry, I mean, there's a wide range of industries that tend to be targeted b to b services, software, technology, healthcare, and several others. So in my case, I ran a software company, again, a very asset light business model with a lot of recurring revenue. And recurring revenue tends to be another widely seen characteristic, because it lends itself quite well to a first time CEO running it. And maybe that's an appropriate kind of title page to put on it is you're looking for both a business model and an industry that lends itself very well to a first time CEO. So what's an example that does not fit that description, maybe like a mining company, for example. That would be like the antithesis of a search fund investment. But something like a software company, an alarm monitoring company, a staffing agency, a managed service provider, those tend to be all like asset, like businesses that demonstrate recurring revenue characteristics. And broadly speaking, lend themselves reasonably well to a first time CEO running them.
Ronald Skelton 12:35
When you say the first time CEO, are their search funders out there who, like, you know, people that are putting together funds looking to buy companies that you would, maybe they've already sold a company or anything? Or is it just primarily straight out of college?
Steve Divitkos 12:49
No, it's all the above. Basically, any entrepreneur who is looking to purchase a business and subsequently assume the CEO role is totally fair game for a search fund. So, it can be as kind of inexperienced as someone coming straight out of business school with maybe only a couple of years of work experience under their belt, and can go all the way to an entrepreneur who is in his or her 50s, who has done this many times before and is looking to do it again. The median age at the start of a search is 32 years old, but there's a pretty wide standard deviation around that median. So any and all entrepreneurs who are you know, effectively looking to do this, there's, there's certainly no, no recipe or formula that needs to be followed.
Ronald Skelton 13:33
It's interesting is uh, I have a group of people I know that are in acquisition entrepreneurship. And, you know, I was talking with some of them. And, you know, other than they've joined search funder.com. A lot of them didn't, weren't taught, and didn't know what search one was, because they went for straight from owning or running their own business to deciding they want they either sold, exited, or whatever. And they decided they want to buy another one. They've hired mentors, coaches, or whatever to help them do that. But I'm not going to traditional route. It's not a very common, you know, it's just like one of those things if you don't know about it, you don't know about it, right? A lot of people don't know what a family office is.
Steve Divitkos 13:33
And to be fair to those listeners, prior to going to business school, I didn't know what a search fund was. I had never heard of it. This is not something that you know. One emerges from the womb understanding. In fact, my graduating class was 2012. That was the first formal entrepreneurship through acquisition or search fun class offered by the school at that time. I think Stanford might have been the only one prior to that point that had formalized ETA education. So, you know, for that reason alone, the randomly selected listener cannot be blamed for not necessarily knowing what a search fund is. Now, I would suggests that substantially all of the leading business schools in the United States now have formalized search fund or entrepreneurship, through acquisition courses, as well as student run clubs and things like that. So it's it is very quickly becoming part of the formalized education process at a pretty wide range of business schools, not just in the US, but now across the world.
Ronald Skelton 15:26
We do have a small section of our listener base that are the on the investor side, meaning not just they invest in companies, but they'll help fund deals and stuff. What is in it inside of a search fund? What is in it for the investor?
Steve Divitkos 15:42
Yeah, so speaking of the kind of formal search fund, structuring mechanism, as mentioned, for investors like me, who fund your first two years looking for a business to buy, from the entrepreneur's perspective, you know, first off, they get a meaningful salary while they're looking for a business to buy. And they get on average, a group of 15. That's how many investors tend to be part of the average cap table, experienced investors who are both ready and willing and able and excited about helping them in any way that they can. In return for that we, as investors, get the right of first refusal to invest in the deal in question. Once the company has been identified, it is the right but not the obligation to invest. Once the search entrepreneur presents the opportunity to investors, we say yes. You know, individually, we say yes or no. And to the extent that one of us says no, than the entrepreneur is free to raise money from wherever they want. You just have to kind of give us the first look. In addition to that, as investors, I mean, you know, I often used to say, when I was running my company, the unfortunate reality of having investors is at some point, they need their money back with a suitable return, hopefully. So, as investors, you know, we get to invest in really smart, really driven ambitious, high integrity entrepreneurs. We get the opportunity to work with them frequently. For example, we tend to sit on the board of these companies that helps the entrepreneur and what are probably obvious ways, but it's also incredibly fulfilling and interesting and satisfying for folks like me, who have kind of been in the CEO seat managing a board. And selfishly, we get to invest in some awesome businesses run by awesome entrepreneurs. And it's, it's a cool space to be in, especially as someone who has worn the CEO hat and knows what the blood, sweat and tears feels like, the opportunity to utilize and leverage the lessons learned and mistakes made to help not just one entrepreneur, which would be the case, if I just decided to do it again, but to help dozens of entrepreneurs running dozens of different companies across, you know, potentially dozens of different industries. So it really provides investors like me with a way to kind of scale our experience in our time in a way that allows us to be as helpful as we can, to as many folks as we can, while still maintaining an intimate relationship with each of them.
Ronald Skelton 18:09
Got it. Now, guy comes, you know, out of college or out of a business, they're looking to acquire their next business, that, you know, kind of jokingly, you know, they kind of know what they want to do when they grow up. So you kind of got an idea, and what industry most people kind of have an idea of what industry they'd like to play in. Do they put together a proposal? a document? Is there a pitch to you guys?
Steve Divitkos 18:37
Yeah, so what will take each round of financing in turn. So starting with the first round of financing, this is when the entrepreneur is just raising what's called "Search capital", which is exactly what it sounds like, the money to fund the search. So at this point, the entrepreneur doesn't have a lot to go off of with respect to raising money. They can tell investors about themselves, what schools they went to, what jobs they had, why they want to do this, etc. Often, the document in question is called a PPM, or a private placement memorandum that is effectively the only document that investors like me have to go off of when deciding whether or not to fund any entrepreneur search. Almost always in any given ppm. One of two things will show itself with respect to industry. Option number one is, let's say an entrepreneur has a very, very specific industry thesis. Let's say he or she used to be the CFO at a sleep clinic, and they say, You know what, I love everything about the sleep clinic industry. I'm going to scour the earth and find one sleep clinic to buy and operate in the United States. That does happen. Other times. It is more of a opportunistic or industry agnostic search that says, hey, I don't know exactly the industry I'm going to buy in yet but here are the characteristics of the industry. Then I'm going to look for. And here are three example industries in which I'm actually going to start just to make this a bit more of a managerial process. In that latter category, what ends up happening most frequently is the entrepreneur suggests, let's say two to three industries that she intends to buy in very, very, very frequently. She does not buy a company in any of those industries. And as a searcher myself, I think I can speak to why. Number one, I think one of the things that I learned is just the staggering, overwhelming number of companies, small private companies there are in North America, and by extension, the overwhelming number of industries that exist in North America, most of which Ron you and I have still never heard of. I remember working with brokers, you know, business brokers, investment banks, accounting firms, etc. And I would get a offering memorandum from them. And in many cases, my first reaction after reading it was, Oh my goodness, who knew that companies like this existed, like who knew that this industry existed. So I think that reality is probably one of the reasons that informs why many search entrepreneurs don't actually buy in the industries that they set out to buy in. The second would be, again, informed by my experience searching. Let's say you really like industry X, but then you take a deep dive into industry X, and maybe the valuations are too high, or maybe just not enough companies are for sale. Or maybe there's a private equity firm that's consolidating the industry, and you just can't win on price. And maybe in the course of evaluating industry X, you actually learn about a industry that is tangential to it. So maybe they're a service provider to it, maybe they sell products into it. And the more you learn about that industry, sometimes you say, Oh, this is actually more attractive than industry X. I'm gonna pivot there. So this is all to say that in the course of a two year search, which tends to be the case in a formalized search fund structure, man, there's just so much that you don't know there's so much that you can't predict. And there's so much that just kind of emerges naturally, that in more industry agnostic searches, new industries tend to present themselves in new and interesting ways.
Ronald Skelton 22:19
I've come across companies that, you know, on the face, like I just talked to a guy yesterday, unfortunately, he's way too small. But you know, the initial call was, hey I've got a roofing company for sale in Oklahoma. Well, I own a bunch of real estate there. And, and even though I said in California, now I own some other companies that are so I wanted to talk to him. And turns out, he doesn't put shingles on roofs, these Roofing Company, but they answered the phone, they placed bids through satellite photos and stuff like that, and they farmed them off to contractors. They never, they never stepped foot on a roof. And, you know, the industry changed a little bit for them. So that's why he's trying to sell is it's becoming harder and harder to make money, the insurance companies cut it. But I didn't even think that there are middle guys out there that all they do, is there lead the pretty much a lead generation companies all he really is. Yeah, you know, he and then the other one, is I just said, there's still companies out there that are flourishing very well that I didn't you wouldn't think they're still around as much, right? So I get that. I, you know, I've got a fascination in the last few months, I'm searching, looking at coffee roasting companies that have subscription based on it. And I don't even like coffee. I love the smell of it. I just I detest the taste. But the business model fascinates me. right? It's a loyal customer base fairly recession resistant. And the guys that do really well with building subscriptions into their system can do really, really well. It's kind of like, No, all these box services, you know, business in a box type of stuff. But
Steve Divitkos 23:53
Yeah, almost . I mean, look, without the risk of exaggerating, almost daily I learned about a company operating in an industry that I barely knew existed. And that's after a decade of being deeply immersed in the small and medium sized business ecosystem. And I suspect that 10 years from now, we'll be saying the exact same thing.
Ronald Skelton 24:14
You know, when I got into this face, I didn't know what a family office was. I was like, I just never heard of it. And some of the other stuff that goes along with that. You know, I've met at least three people now their whole job in the world is they go out and find businesses for family offices to buy, and they get paid extremely well and, you know, maybe even get a little bit of equity on the deals they, they placed with these private equity. Sorry, these family offices. Right. And so yeah, you're right, there's just so much to discover out there. You know, when I first got into this, I kind of thought I was getting into, you know, I own a pest control company. I'm gonna buy some more pest control companies, buy something real estate related. Maybe things that complement that. And, you know, things like cleaning services, they you know, who finds more bugs than a house cleaning company? You know, I would still buy one. I mean, I'm not saying I wouldn't. But there's just so many things out there that are more fascinating. And that's some of the stuff I really started searching for. So I get that. So, let's talk about, kind of, we know what we're looking for, we kind of got a general class, like, I know, I'm looking for a company doing 5 Million and above, at least, you know, close to a million or butter in ebita, you know, 10 or more employees? Well run, I mean, I've got a list of stuff that I have as a criteria. You know, so we know what we're looking for. And now we're talking to people, do you guys step in and help with any of the evaluation or negotiation on price or anything like that?
Steve Divitkos 25:57
Again, I think the role of the investor is very multifaceted. And I would suggest that the role that I play with search an entrepreneur A could be entirely different than the role that I play with search entrepreneur B. I think there's probably two ways to answer that. Number one is, I think, I know search entrepreneurs go into this to become entrepreneurs. And what I mean by that is they tend to value independence and autonomy, and freedom. Otherwise, why did why on earth would they become an entrepreneur. So typically, they tend to be driving the bus. But as investors, we tend to be as active as they want or need us to be. So you know, give one example. When I was buying my company, ability to close the deal is understandably a variable that sellers consider very deeply. They don't want to go through the pain and effort of diligence and legals only to find that the buyer doesn't have the wherewithal the resources to close the deal. So in some instances, I would loop in my investors and have them speak to the sellers. And I, you know, there are instances where some investors might come in and say, look, I can, I can finance this deal by myself if I wanted to, but there's actually 15 of me. You know, in my case, now, as an investor. I run a fund, you mentioned family offices. We have many family offices, as well as high net worth individuals as our limited partners. So the entire purpose of the fund that I now run is to write checks to buy small and medium sized businesses. So that's a very tactical example of a role that an entrepreneur or, pardon me that an investor could play, and in my case did play. In other instances, you know, let's say if the searcher has a private equity background, she is probably reasonably comfortable with valuation and structuring. So we are there to help her, you know, as and when she needs. In other case, and again, I'm painting with a very broad stroke, there's going to be lots of exceptions to this. In another case, you know, we can consider the example of an entrepreneur who has no transaction experience. Maybe they came from a sales background or general management background. In instances like that, they tend to want a lot of help from their investors in trying to figure out hey, what is this company worth? How do we structure it? How do we mitigate risks A, B, and C, and In instances like that, investors will be very active. So I think the best investors in this space, or at least the best investors that I had experience working with myself, are those that never impose their will on a searcher, which is to say that they were as active or as passive as the entrepreneur wanted or needed them to be.
Ronald Skelton 28:43
Awesome. What's the, I guess, as an investor, your long game is there's an exit. There has to be in some way for you to get your money back. right? So either there's a way for them to buy you guys out, or there's an exit, do you help facilitate running the company so that you can maximize the we're encouraging that right. There's a different way to run something if you plan on selling it, then there is if you're just trying to minimize your taxes? You know, your tax taxes and, and, you know, have a, have a comfortable life run into company. right? So I'd
Steve Divitkos 29:19
Yeah, so investors, so with search acquired companies, there's always a board of directors in that board of directors plays kind of exactly the role that you would think a board of directors ought to play very, very typical of like a traditional private equity relationship between CEO and board. So, in that way, investors can play a very active role in the company. Now we are not nor should we ever be, you know, running the day to day of the business. We're not figuring out if you know, employee a deserves a 2% raise or not. But on a quarterly basis, we're working on at least a quarterly basis. We're working directly with the CEO to deal with issues financing and strategy, and hiring, and the investment profile and capital allocation, and on and on and on. Outside of board meetings, good investors can and should be intimately in regularly connecting with their CEOs to again be as helpful to them as they possibly can be. Typically, in a traditional search fund structure, Look, liquidity is a reality. Like I said before, investors need their money back. That is the very nature of investing. So, most frequently, but not always, it is some sort of exit event. The average hold period is somewhere between, you know, five or six years, maybe we're five or seven years. Afterwhich, there's typically some sort of exit event, whether it be a sale to a strategic sale to a private equity firm. But that is just one way for investors to get their money back. There could be a recapitalisation, where you change the mix of debt and equity on the business after the consummation of the original transaction. There could be share repurchases, which is something that I did as a CEO, I bought out the interests of investors at a suitable return for them. And as a result, myself, and existing investors got a bigger share of the pie. So just like with any investment, there's really no limit on what you can do to create liquidity. And though most search funds tend to seek liquidity through some sort of exit event, that is not always the case. So there are plenty of, you know, very specific examples that are coming to mind where the entrepreneur said, Look, I'm gonna raise a search fund. But you know, at the end of the day, I just want to run this business forever. This is what I want to do for the rest of my life. So over time, what they did is they use the cash generated by the company and or other sources of capital like debt to buy out investors. And over time, what started as a cap table with the search entrepreneur and 15, investors turned into a cap table of one, which is just the CEO. And in this case, it was a he. He ran this business. You know, he continues to run this business to this day. So there's, there's really kind of no limit on the mechanisms that entrepreneurs can use to, to get liquidity for themselves and or for their investors.
Ronald Skelton 32:21
So I know myself and some other guys were looking to, like, the strategy I'm looking at is by a what I call an anchor business, and then acquire growth or acquisition. Right. So in your scenario, a search fund scenario, an entrepreneur buys a business, and they're running it, and they're looking at ways to grow it. You guys support and help fund subsequence. I can't even say the word subsequent acquisitions to where they're acquiring. For acquisition, I mean, for growth.
Steve Divitkos 32:57
Very frequently, very frequently. So you know, again, just to illustrate, you know, to, I guess, extreme, for lack of a better way to put it examples. On one hand, a search entrepreneur can buy a single business and just say, Look, I'm not planning to buy anything else. I'm gonna create returns through capital structure, capital allocation, organic growth, etc. On the other side of the spectrum, an entrepreneur could say, hey, industry, XYZ is incredibly fragmented. You know, the largest player in the space owns less than 5% of the market. It is owned by a bunch of, quote, Mom and Pop operators. I'm going to buy one company as a platform, and I'm going to use that platform to roll up a bunch of other ones. And that's how we're going to create growth. Okay, great. And then anything and everything in between. So, again, there's kind of no limit, necessarily, on the value creation strategy that's pursued.
Ronald Skelton 33:51
So, I love the fact that it can be as creative as both the investor and the entrepreneur can agree upon, right?
Steve Divitkos 33:58
That's right. I mean, it's just like a simple capital allocation decision. So if the company in question has, I don't know, I'll just make up some numbers, 2 million bucks kicking around? It is the CEO's decision along with the board to say, well, what is the highest and best use of this 2 million bucks? Should we hire some more people in our existing business? Should we release a new product? Or should we just go out and buy a competitor? And it's a capital allocation decision? It is where to on a risk adjusted basis? Where do we see the highest return? As it relates to the use of that capital? So like I said, there's kind of nothing kind of profoundly restrictive about search investing. In instances like that, it would be a matter of the CEO sitting down with her board and saying, okay, you know, here's what, we've got some liquidity. I want to pursue growth, you know. it can either be through, you know, investing in existing operations, buying new companies, repurchasing shares, issuing dividends, you know, whatever the case may be,
Ronald Skelton 34:56
You know, we've got a business up and running. We're working with you guys. I'm familiar, I wouldn't say I was an expert in, but I'm fairly familiar with the VC route just because I came from the tech industry and was around it for a while. In that route,You know, it's a start up, is an idea, it's high risk for the investor. And they're playing, like I always say, they're their unicorn hunting right there. They're looking for, you know, they invest in 10, 15, 100, 1, or 2, (inaudible), and they make enough money to make up for all the ones that don't. This seems like a lot safer or less risky of an investment strategy for you as an investor, because they're acquiring something that's up running, producing revenue. And if you do your due diligence, you know, it's a fairly sound company. And, you know, kind of half joking aside, it's for the entrepreneur to either succeed or ruin it. right?
Steve Divitkos 35:53
Yeah, yeah, that's right, that the risk return profile is very different from venture capital. As you correctly pointed out, I often think of venture capital investing is like lottery ticket hunting, like you're just kind of holding a lottery ticket and hoping that one of them hits, and in a portfolio of ten, nine businesses will return less than one times the investment, but one business will return 100 times your investment, and that'll be your whole fund. With respect to search funds, it's very different because recall that the businesses that we are buying tend to be 20 plus years old, are almost always profitable, or almost always growing, already have product market fit already have dozens of employees already have recurring revenue streams. And so I often differentiate between zero to one businesses and one to N businesses. Zero to One businesses is what venture capital is focused on, you're basically creating something from nothing, which is incredibly difficult to do. Bring your business from 1 to N, so that 1 to 2, 1 to 5, 1 to 10, that's still incredibly difficult to do. But I would argue that it's a bit easier to do to optimize or improve something that already exists, as opposed to creating something from scratch. So, said another way, it's easier for me to take a business that's making $10 million in revenue has 300 customers. And from a value creation standpoint, if it has a really sticky product, maybe I raised the prices by 10%. I've just created value there. That's a lot easier than trying to find my first customer with my first product, right? It just is. So while venture capital can produce, you know, 100x returns, since 1985, search funds if we can think of it like an asset class, so to speak, on average over the 530 or so that have been launched. Since, since 1985, the average IRR to investors, or internal rate of return, is in the mid 30s. And the average multiple capital is 5x. So, as an asset class, search funds over the past couple of decades have outperformed public markets, private equity, private debt, infrastructure, real estate, and venture capital. So even though you know, I remember 10 years ago, when I described a search fund to my mom, for the first time, she was like, What the hell are you doing? I don't really understand what this is. It sounds a bit ridiculous, admittedly, that an inexperienced entrepreneur who's never run as much as a lemonade stand in his entire life is gonna go buy a real business and be the CEO of it. But clearly, we've got a couple of decades of data to suggest that there's something here and this works.
Ronald Skelton 38:39
I got it. Now inside of the inside of the VC route, if you there's two parts of this question, I'm trying to figure out a format. So I'm gonna take a different route. So in my experience, in my opinion, I honestly think it takes a different person, a different CEO's skill set, did go from an idea to selling product number one that it does from going selling product number one to say about the 5 million mark, maybe the 10 million mark, but there's a there's a point in which it's no longer bootstrapped. It's actually running and the growth strategy and everything kind of needs to shift. And it takes a different set of skills to go from that. It's just a 10 million to the 25,30. And I don't honestly I think there's another level once you're at about 25. It's a whole, whole different skill set to get from 25 million to 100 million. I know in my search, what I'm looking for and where I fit in, I would probably run that 5 to 10, maybe up to 20. At some point, I honestly know I need to pull myself out and put a different CEO in, right because there's, there's a difference, especially if you start looking at things like going public and other stuff, right. What is the approach from search funds? For me, you guys on guidance towards these entrepreneurs, when it's time to tell them like, hey, look, if you want to take this any further, you probably ought to bring somebody in with that skill set.
Steve Divitkos 40:09
I think, in many ways, I would enthusiastically agree with what you just said. And I think the reality of what you just said underlies why search funds exist in the first place, which is to say that founders,founder CEOs who founded the business 20 years ago, and they're still running it, oftentimes, the realization that leads to a sale in the first place, and specifically a sale to a search fund, is just that the founder says, Hey, I've taken this business as far as I can, it's been 20 years, I'm incredibly good at taking a business from nothing to something. But now, that let's say, we're at $10 million of revenue, a new set of eyes, a new set of skills, maybe a new infusion of capital is necessary to take this business over the hump and get us to our next growth inflection point. So I think that reality that you accurately pointed out, in many ways, explains why search funds need to exist in the first place. Now, as the search fund entrepreneur, you know, I ran my company for seven years. I came to the realization kind of for a second time, which is, hey, now I've been running this company for seven years, I've taken it from x to y. Now, either something new or something different is required, as it as it relates to me, which is one of the reasons that led to the sale of our company. But also, you know, in the course of managing the business on a day to day basis, hiring your management team and your employees, that's a very, very real consideration for CEOs. Oftentimes, you know, just to try to kind of paint the picture, this specific example, the VP of sales that you hire to stand up your sales team from a non existent state, and take it from $0 of direct sales to 5 million of direct sales, that might not be the same person to take it from 5 million to 20 million. Same with your controller, right? Maybe that needs to become a CFO, same with your marketing team. So I'm not saying that individuals and members of management teams can't do that. Because there are people that can kind of grow with a business. But in many, many cases, CEOs need to realize that the people that got you here aren't always the people that are going to get you to the next step. And of course, that's one of the many, many challenges that small business CEOs need to deal with. Because, heck, if someone put in the blood, sweat, and tears to get you from zero to 5 million, it's really, really difficult conversation to have to say, actually, we need someone different to take us from 5 to 20.
Ronald Skelton 42:46
I get it. And, and I've seen that be very detrimental. I'm almost out of a few companies, right? That, you know, and I've actually turned away at least one acquisition because the person selling the company was very adamant that the I couldn't, you know, that they didn't want me to let go of any of the leadership staff in the first two years, right? He's already promised that, you know, um, so they already promised their team. I'm selling the company, but whoever they sell it to, I promise you had a job for at least two years. And I just couldn't commit to that, because their sales guy, I honestly, he was stuck, right? I honestly believed in I've done sales before. One of my favorite questions to ask anybody in sales is what's the most you've ever made in your life. And the reason is, is there's an inherent value that somebody thinks they're worth, and they'll bust their tail to get back to that. But after that, they almost sit on their laurels, if you get the wrong person. This guy was very comfortable. He was a mid six figures with what he was earning because he was a good sales guy. That's the most he's ever earned. He was making slightly more than made it the last company. And he thought that was a gap of it, you could just tell the level of effort he put to get to where he was, did not exist anymore. So you know, it was time to, to find that guy that could do to move the company from that to the next level. And so I've seen, I've seen business owners, I've seen, you know, acquisitions that just didn't go through. Because, you know, they were so concerned about, hey, you know, these three people that worked for me for 30 years, you can't fire them. I was like, well, first of all, you know, I'm acquiring the company. I'd love to keep everybody around forever. But that's not the nature of business. And, you know, just can't make commitments like that.
Steve Divitkos 44:47
Yeah. and an entirely understandable situation from both perspectives. I can empathize with the seller in that case, because I'm sure you know, the members of his management team. You know, we're in the trenches. with him for 30 years, as you mentioned, and he wants to do right by them totally understandable. From your perspective, you're buying a business and you don't know these managers. Maybe, if you're lucky, the seller has allowed you to speak to them. But in many cases, sellers are not comfortable doing that. So if you're lucky, you've spoken these people a couple of times, but you don't know whether you're going to keep them or not. And so, you know, in a lot of instances, when you buy these small companies, I think the reality of buying small companies, that is not necessarily the case in buying larger companies, is A many of them tend to be founder centric. And so in buying these businesses, you have to figure out, am I buying a business? Or am I effectively buying like the founders job? You certainly want the former, not the latter. You also need to figure out what does this business look like without the founder? Does this founder own the customer relationships? To the extent that this founder leaves, what does that do to employees or customers, or suppliers. And then, on top of that, you're inheriting this employee base, and in most cases, you kind of know nothing about them effectively. And so it's very common for employees when any given company is sold, particularly small businesses. I would suggest that my experience, or pardon me, my experience would suggest that the number one emotion is fear. Everyone is scared and uncertain of what's going to happen. So one of the consequences of that fear is employees will ask, Well, are there going to be layoffs? Is my job safe? And as the incoming CEO, of course, you want to answer that question in the affirmative. But if you're being honest, you can't write because you don't know who's gonna stay around, you don't know who's an A or a B or a C performer. You try to be as democratic as possible, and suggest that, hey, if you're creating value for the business, given my pursuit of growth, of course, I'm going to keep you. In fact, I want to hire more versions of you. But you can't just blindly agree to keep members of a management team or anybody else for that matter, because you just have I mean, look, someone starts stealing from the company, I'm getting rid of you, right, regardless of what I promised to do. Now, that's an extreme example. But it I'm using an extreme to illustrate the point that, as an incoming owner of a business, it's really, really tough to commit yourself to something like that.
Ronald Skelton 47:14
You know, and I've never seen, you know, I joke that jokingly say all the time, I believe there's a such thing as a better employee. Some employees just be better flipping burgers for somebody else, and not working at my company, right? They're not, you know, they just may not be the right fit here. That said, almost every business has been around for 20 or 30 years have some has somebody or a group of one or two people there that are there because the company's just been loyal to them. And they've been loyal back, yet. They started to exhibit what I refer to as toxic behaviors, right? Negativity, hey, we've already tried that type of stuff. I just, it doesn't work. Right. And I see this a lot. You know, that's one of the things I see a lot, even entrepreneur. Friends of mine will do, hey, I got this employee. And you did this, this, and this, like, okay, why don't you replace them? Why I never do that? He's been here for 15 years. Yeah, And, you know, like, there are 7 billion people on this planet, maybe close to 8 billion people on this planet, I'm positive. There's somebody out there with the skills that will give you what you need without the nightmare that this individual is causing for you and your organization. And in the case, I'm taking about one of the guys, he was bad enough that people around him were leaving, because I just didn't want to work with the guy. Yeah, but the owner did not want to let him go. Because like I said, then there for 15 years, 15, 20 years, or whatever, knew the business inside and out and had some key information in his head that the owner didn't want to lose. And I'm like, okay, probably got a document that fairly detailed and start trading that it's just a bad. That's there. It'll be in, in to start with. Right.
Steve Divitkos 49:07
Yeah, And it's so common, like so, so common. I mean, I can't tell you how many instances like that I had to personally deal with. And certainly now, as an investor through secondhand experience. This is one of the 1000s of things that keep small business CEOs up at night, right? So again, to illustrate a common example, and maybe a really difficult one, You know, it's not abnormal for small businesses, to let's say, have a sales team of, let's say, three people, right? What happens if your highest performer that is generating 80% of your sales, is a total jerk and nobody wants to work with him, and he is a cancer to the culture. I would suggest that you get rid of that person. Now, of course, the evaluation needs to be much more nuanced than that. But you know, I tend to think about it in the content, in a context referenced by a book called Traction by Gino Wickman, that I really recommend to all of your listeners. They think about people in the right seat and right person capacity. So in the example that I'm using, maybe the salesperson is in the right seat, he understands his job, he wants his job, and he's demonstrated a capacity to do his job successfully. That's great. But is he the right person, right person in my instance. And in my case, we defined by the core values of the company. And if he or she is not demonstrating the core values of this company and is, in fact, toxic to those values, and the culture that you're trying to create, there is not actually the right person. So very, very difficult. consideration and something that I know keeps countless CEOs up at night certainly kept me up many, many nights when I was running my own business.
Ronald Skelton 50:53
Hey, Steve looks man, it looks like we're hitting the top of the hour here. We're hitting the end of their show time. What's one big takeaway that we can have? As far as like something that's the main thing people need to know about what you do in search funds?
Steve Divitkos 51:07
Yeah, I mean, maybe it's instructive to go to where we started, which is to reiterate the concept that acquisition entrepreneurship is not anything particularly new for a very long period of time. People have always been looking to pursue their entrepreneurial dreams through acquiring an existing business. You know, maybe for folks who are less familiar with the concept of a search fund, I guess, it may be instructive to reiterate, or to remind people that this is a way to put some structure in some process and some guidance around what is otherwise a very intimidating undertaking as someone who was a solo searcher, meaning that I didn't operate with a partner. For what are probably various obvious reasons, I found it to be an incredibly lonely journey. for many different reasons. But I think when you surround yourself with investors, as I did, you know, you come to appreciate that, while you may be alone, you don't necessarily have to be lonely. When you get folks on your team who have experienced doing this, who have searched themselves, who have acquired themselves, who have operated as a first time CEO themselves, there's just a lot of mistakes that don't need to be made for the first time again, and to the extent that someone is considering becoming an acquisition entrepreneur, but maybe is a bit worried about their lack of experience. Maybe they don't have transaction experience. Maybe they don't have leadership experience. There are ways that, you can structure around that and I found a search fund was just such a structure.
Ronald Skelton 52:52
That's awesome. What would be the best way for people to reach out to you? How would you prefer people to get in touch with you if they have something that they want to chat with you about?
Steve Divitkos 53:00
Sure, so my website is Mineola, search. partners.com. Again, Mineola is spelled M I N E O L A. I'm also very findable on LinkedIn. My last name is Divitkos D I V I T K O S . I also for whatever it's worth, publish a blog and host a podcast myself on about being a CEO of a small to medium sized business, including buying companies, selling companies running them and managing yourself and managing your own psychology. Both the blog and the podcast are called in the trenches. So to the extent that anybody who's interested in checking that out, please feel free to do so. But otherwise, yeah, website is probably the best place to reach me.
Ronald Skelton 53:43
Awesome. Yeah, once you if you listen to this podcast, check this podcast out. I'm a big blue ocean strategy guy, I really think that there's a lot of information out there, and you're brilliant in what you do. So I think people gain a lot from listening to your podcast. What if what is? Is there anything myself or I guess we always ask to do the show? What is one thing or something that myself or the audience, can do for you? Is there something we can do to help you succeed in what you're working on?
Steve Divitkos 54:11
Well, I appreciate the question, appreciate the offer. I think the first thing that comes to mind is, you know, acquisition, entrepreneurship is a small ecosystem, I think, as we all know, and to the extent that anybody listening is either themselves or know somebody who is considering either raising a search fund or purchasing a small to medium sized business somewhere in North America. For obvious reasons, I'd love to love to speak to them love to be helpful to them in any way that I can. And certainly to the extent that they're looking for external capital to finance their acquisition, I mean, that's that's something that I'm obviously very interested in as well. So we'd certainly welcome any and all opportunities.
Ronald Skelton 54:55
Awesome. Every two weeks, we're actually hosting a kind of a networking thing where acquisition entrepreneurs get together on Zoom. And we what are they working on? What are they looking to acquire. And it's sponsored by how to exit, but I'm just I host this networking meeting, that would be a great place for, for the listeners to jump in. If you ever want to join in on that, I'll invite you to the upcoming ones. But we spent about an hour and a half, and just get to know people in the industry, what they're working on what they're looking for, what their search length is. And a lot of times they have, you know, questions or, you know, hey, I've got an LOI signed, I need to do due diligence on this person, I'm lost. So we, we, we share our resources and like who we use the last time and how we do things, and just help each other move forward. So
Steve Divitkos 55:42
yeah, that great we should all be we, should all be helping each other. I mean, like I said, this is a lonely journey, no matter what you do, whether you work with a partner, whether you work with investors, is a difficult, lonely journey. There's more than enough companies out there for all of us, there's more than enough resources out there for all of us. So, you know, even as someone who invest myself, who hosts a similar podcast, Ron, I mean, listen to as many podcasts you can read as many books as you can talk to as many people as you can. And I benefited, you know, over 10 years ago from so many other acquisition entrepreneurs who gladly took my phone call when I had absolutely no idea what I was doing. And the help that they provided me with was invaluable. And now that I'm on the other side of the table, you know, I think I speak on behalf of the vast majority of folks who have done this before in that I and we legitimately enjoy having these conversations. It's kind of fun to, you know, hang up the phone and feel like you've genuinely helped somebody, because you know, what it feels like to be on the other side of the table. So, you know, let's continue to make this a strong community and in every sense of the word in a rising tide lifts all ships.
Ronald Skelton 56:49
I believe that 100% Thank you for being on the show. That's it, guys. Hey, it's your host, Ronald Skelton. I want to thank you personally for watching the show today and invite you to call our new hotline 918-641-4150. That's 918-641-4150. Call us and tell us about our show, ask questions, suggested guests or even tell me about a business you have for sale and we'll reach back out to you. Again that number is 918-641-4150. Call our hotline leave us some information. Thank you. The investors and entrepreneurs professional mastermind. The investors and entrepreneurs professional mastermind combines that additional peer to peer mastermind introduce first in Napoleon Hills famous book Thinking Grow Rich. With accountability partnering, where your peers help you ensure that you set goals take action and get results. If you want to scale blow past roadblocks and achieve success faster than you might think is possible, I suggest you take a visit over to tiepm.com That's T i e. P m.com. And check out the investors and entrepreneurs professional mastermind.