Searching soul and $: what we learnt at a search fund conference

Last weekend, we dropped by Paris for a search fund conference organised by three business schools. 

Notwithstanding the few corny jokes (sample: “How can you spot a PE investor in a cinema? He enters backwards and keeps looking at the exit!”), the content was more than worthy of a write-up. For your convenience, we organised it in 3 topics:

1. The case for search funds / Entrepreneurship Through Acquisition (ETA)

2. How best in breed searchers approach deal prospecting and negotiation

3. Insights from a prolific capital allocator

Part 2 of our search fund series - due tomorrow - will feature a tear-down of Water Direct, a $30M+ revenue UK search fund acquisition. 

The backdrop

Still early days for the European search fund ecosystem despite the fact that the continent’s first ever search fund was raised over 30 years ago, in the UK.

The business schools behind the event - IESE, INSEAD and LBS - are blazing the trail. We noted the large number of dedicated search fund investors in attendance, including Istria, Relay, Ambit, Cabiedes, Ryton Equity, 9T, and ALZA. They all seemed to know each other! 

Britain is the most active market right now, characterised by healthy supply of both investors and sellers, with competition to boot. It is closely followed by Spain where searchers benefit from good availability of SMEs facing succession challenges, and the banks are happy to fund such buyouts. Italy and France are “6 to 8 years behind Spain”, according to one investor. 

Frankly, we were surprised to see France at No.4. Perhaps a matter of taxonomy? We see family offices increasingly act as single LPs. For example, Otium Capital - the investment vehicle of Pierre-Edouard Stérin - is bankrolling Comet Software with €60M on search fund-like terms. 

In the Nordics, searchers face stiff competition from both mid market PEs and HoldCos alike (read our primer). 

In Germany, domestic bias (which filters out a big chunk of hungry MBAs produced by INSEAD etc.) plays to the advantage of institutionally funded “aggregators of aggregators” like Chapters Group (yes, we have a primer on them too!). 

What’s the point of search funds? And how do they compare to PE / VC? 

Lenka Kolarova from Istria Capital, one of the first homegrown European ETA investors, ticked off the reasons for allocating to this asset class:

• Comparable / better returns vs. VC “but with a fraction of the risk”

• Opportunity to tap into the least efficient segment of PE: the micro-caps

• Genuine value add - investor can mitigate a searcher’s lack of experience (e.g. M&A) with their own experience

As to why someone would start a search fund vs partner with a PE firm:

• Relatively inexperienced people can become leaders (vs. the “PE stands for Prior Experience” mantra)

• No single investor can dictate exit terms

With that said, there is growing overlap between search funds and PE given the fact that the latter often buys from the former and goes on to achieve similar or better returns. Little surprise then Long Term Hold is growing in prominence as a sub-strategy, producing outsized returns in deals like Pacific Lake / Banyan. 

Insights from a prolific capital allocator

Jose Martin Cabiedes is a IESE professor, a don of the European search fund industry - and a prolific investor himself. Here’s what he had to say about capital allocation:

• Search fund investors chase equity style returns - typically 3-5x MOIC

• They are not hands-on investors. With that said, Jose firmly believes that Board composition should reflect cap table - and not necessarily expertise

• Buy and build is not a natural fit with the traditional search model, especially if the add-ons cannot be funded with debt or internal cash flows. That said, the recent sale of Tikedo, a rollup of manufacturers of self-adhesive labels, must have netted a tidy return for its backers

Note from Rollupeurope: based on a Stanford / IESE study, international search fund returns have been a) more consistent but also b) much lower vs. North America. Admittedly the international sample is heavily weighted to newly acquired companies that have yet to deliver appreciation.

Origination advice from successful searchers

Data driven insights from a panel: 

• “If you don't sign an LOI in the first 6 months of the search, the probability of success decreases significantly” 

• “I spend no more than 4 minutes on the first call”

• “Recurring revenue is paramount. <10% EBITDA margins: commodity. >30% margins: how sustainable?”

• A French searcher talked about employing 8 full time interns in the summer and 2 otherwise. 25 calls / letters per intern per week. Toolkit: Lemlist for outreach automation and Pipedrive for CRM

• “When it comes down to closing deals, your learning curve is exponential. If you can achieve a cadence of >1 LOI / month, very quickly you become proficient at negotiating deals”

Finally, Adam Johnson from Water Direct recounted his experience of acquiring a UK emergency drinking water supplier. The deal took over a year to get over the line, during which time it had nearly died 3 (!) times and Adam lost half of the original number of investors (7 out of 14). Still, he got it over the line - for £7M less than the indicative offer - and has since completed an add-on. 

Taking a step back… How exactly are these deals structured? 

Check out our deep dive on Water Direct.