Speaker 1 00:00:03 Hello and welcome everyone. I'm Peter Lehrman, and this is Masters in Small Business m and A. This show is an ongoing exploration into the vast and undercovered world of small business m and a, where we interview both the proven and the emerging owners, operators, investors and advisors whose strategies and methods for transaction success have been put to the test. The show aims to surface the nuanced intricacies, the key ingredients, and the important factors that can improve your decision making in your own journey in the world of small business m and a. This podcast is produced by Axial, an online platform that makes it easier for business owners and their m and a advisors to find research and privately connect with a diverse mix of professional buyers of small businesses. In addition to learning more about Axial, you can find this podcast, show notes, edited transcripts, and many other related resources all for
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Speaker 2 00:01:02 Peter Larman is the c e O of Axial. All opinions expressed by Peter and podcast guests do not reflect the views or opinions of Axial. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Podcast guests may have ongoing client relationships with Axial.
Speaker 1 00:01:21 Hi everyone, welcome back. This is Peter Lehrman. I'm the host of Small Business Masters in m and a. Great to have another guest on the show today. Really excited about the conversation we're gonna have with Max Arts. He runs the Peterson Search Partners Investment Effort out of Utah. Max, thanks so much for coming on the show and giving us some time.
Speaker 3 00:01:40 Of course. Thanks for having me.
Speaker 1 00:01:42 So Max, before we jump in, you had a really interesting couple of career chapters before you went to Peterson. Maybe just share a little bit about you and just a, a little bit of your story and then we'll dive into to search and a couple of topics that are germane to the present day search and the future of search.
Speaker 3 00:01:58 Perfect. Yeah, happy to. And again, thanks for having me on. It's cool to have known each other for a couple years and now to <laugh>, do a podcast. Didn't see it coming, but this is cool. Yeah. Okay. So the, I guess the baseball card facts, I'm from Cleveland, Ohio, originally went to Babson College for undergrad, did banking right out of college for a couple years at the Royal Bank of Scotland. While I was at R B S, they sent me over to China for six months. I ended up realizing that I loved being in China, but I hated doing banking and so I left the bank and, and stayed over in China for close to three years. I took Chinese for a while and ended up in an operating role, uh, for New Zealand home goods company, and I was responsible for really kind of running the factory over in China, outside of Shanghai.
Speaker 3 00:02:42 Did that for a couple years. Went to business school at Stanford, where I met my now current boss, Joel and I joined Peterson in 2018. And uh, that's sort of at the time it was an interesting inflection point for Peterson was raising a, a much bigger fund, which made it hard to do. Search investments had been a part of the history for 20 odd years. And so Joel and others decided to go out and, uh, raise a fund dedicated to search smaller than the lower middle market fund, and that's what we've been doing for four plus years.
Speaker 1 00:03:13 So were you there at the, uh, inception of that, that first specific search fund investing effort? Yeah,
Speaker 3 00:03:19 Yeah, exactly. Exactly.
Speaker 1 00:03:21 Let's dive into search. I'm particularly interested having listened to a podcast that you were on a few years ago. I thought it'd be interesting to, you know, that was a podcast that was focused a lot on outreach to owners, the owner outreach process. And so I thought it would be fun to take the other side of the coin and just focus on the non-owner outreach, you know, outcomes that occur for search fund investors and for the searchers who, who lead the search process. So in the lower middle market, the micro PE market, there are many owner outreach initiate deal dialogues that occur and some subset of them ultimately consummate a transaction. A huge number of transactions originate through a sell side process that could be very structured and super polished and put together, or not so much. But nonetheless, a sell side outreach process initiates the dialogue and the search fund investor and the searcher can gain access to a deal opportunity through that process. So what I'm particularly interested in hearing about is just what is the state of the art in terms of the way that the searcher community is interacting with and thinking about covering the broker community. And then I want to go from there into sort of what are the winning outcomes and what drives the winning outcomes when there's a potentially more competitive process underway.
Speaker 3 00:04:33 Sure, yeah. We were chatting about this before you hit record, but if you rewound the clock five, 10 years, there was sort of a hex on any non-proprietary deal for a while. And I think that was largely a function of, well, you're never gonna be the highest bidder and brokers are just looking for the highest bidder, and so you're gonna overpay. And that's not really what core, what's core to the model that has changed. And I have seen several searchers close deals on sell side processes over the past couple years. You know, one thing that we chat about early is owners, you need to believe that they have, that they're actually willing to sell for search funds. One of the main resources they have is time. And there's no worse kind of use of time than a searcher going down the path with an owner.
Speaker 3 00:05:21 You get all the, you know, the financials, you start doing diligence, you start to actually move towards a sale and then poof, they're gone. If, if an owner hires a banker or enters into a process, the kind of willingness to sell check boxes marked, you pay for that. But it's a massive kind of signal, right? That, that the owner does wanna sell. Searchers play in kind of many different ecosystems as it comes to processes. They have relationships with brokers, they have relationships with more formal bankers, larger institutions, they go on sites and marketplaces like axial and participate. But what we have found is they are rarely the highest bidder. If they win, if they do win and they end the hard highest bidder, it's usually a <laugh> problem, ironically. And so a lot of the same tenants are the same, right? Some special reason that the owner is telling the banker. I understand there are other bids in play and several of them might be higher, but I'm going with this person because X and sometimes that's, they're from Wisconsin, and so is the searcher. Sometimes they have some unique kind of industry experience. Sometimes, uh, there's more flexibility and structure, but generally they're not the highest bidder in these processes.
Speaker 1 00:06:39 Let's dive into some of these processes and, and dive into how the searcher ultimately unpacks, uh, a winning outcome when they're not the highest bidder. I'd love to just get into the, the greatest level of specifics that's possible within the, the four corners of any compliance or just confidentiality considerations that you have. But what are some of the things that you're seeing you, well, why don't we just for a second, how many active search funds are under your purview at this point in time? Just so that you know, listeners can get a sense for, you know, how much pattern matching and, and data you have at your disposal.
Speaker 3 00:07:14 I would say over the course of Peterson's history, there've been hundreds, I would say at any given time. Right now we're around 20 active.
Speaker 1 00:07:23 Okay.
Speaker 3 00:07:23 Yeah, a lot.
Speaker 1 00:07:24 So a lot of data points, a lot of cycles that you've been privy to. So, so yeah, let's just sort of hear about circumstances in which a search fund is engaged in a dialogue with a banker or a broker. They're interested in the opportunity, they're not the only person at the table. It was not the, it's not an artifact of an owner outreach process. They found the deal either on a inbound receive basis or some other, some other way, but they've decided to spend time on it. Take us through sort of how they go from signing an N D A being just like any other buyer who's received the deal. Take us through sort of how they go from that to, you know, being the winner in a way that they feel good about in the way that an LP feels good about it. In other words, not the winner and subject to the winner's curse, but the winner and on their way to, to a really good potential business outcome multiple years down the road.
Speaker 3 00:08:14 Yeah, and I think I'd be really interested to know who listens to the podcast because I think at this end of the market, there are many different types of players. You have search funds, you have independent sponsors, you have sort of non-funded, but there's a small commitment from a one kind of family office type fundless sponsors. There's lower middle market firms, there's micro ERs, all the above. And so a broker's biggest fear in these processes and anyone at this in the market are gonna get asked this question is, do you have the capital? Right? And it's an awkward question for searchers because the answer is both yes and no. Yes, it's available, it may not be callable, it's not callable, but it is committed and there is a good faith kind of belief that if there's a deal that's found within these parameters that investors will fund.
Speaker 3 00:09:00 So I think that the searchers who to go into processes best first make it abundantly clear to the broker, I have the capital <laugh>, right? I'm not just a independent sponsor who's whirling around the internet kind of looking for deals and need to then go fundraise. It's there. And not only is the capital there, but here they actually are. Right? Here's a list of the types of people and funds and institutions that are backing me. These are the types of deals that they've done that are, here's some of the kind of people who could sit on boards and relevant experience, et cetera. So I think step one is, this is who I am and I have the capital. I think step two would be, assuming this did just come from an axial, for example, would really be trying your best to get in front of the owner.
Speaker 3 00:09:44 It's very difficult. Usually the owners have hired the bankers for a number of reasons. One of them could be, I just don't want it to have all these conversations, but to the extent you really can get in front of the owner searchers I've seen who have won processes are have won because the owner has kind of shooed the searcher in for various reasons. So those would be kind of the, my top two three I would say would be developing a relationship with the banker, right? Like constantly kind of talking to them. If I'm within these ranges, would that get me into the next stage? What are you actually looking for? How much does flexibility matter? Because what you're really trying to do is find that sweet spot between what is the owner and banker looking for? Does that fit with my strengths? Right? If it's strictly they're looking for the biggest check, you're going to lose that process. And so you need to really dig at, well, what's the seller actually optimizing for? And see if you can provide that.
Speaker 1 00:10:43 I'm curious what you think is, who's the buyer who in the conversation with the broker says, Hey, I'm gonna write the biggest check. I'm gonna be the one who pays the most. Like I've never heard a private equity firm, I've never heard a strategic buyer <laugh>, I've never heard, I've never heard anybody say, Hey, if you just want the highest check, I'm your guy. If you know, if you want a bunch of other stuff, I'm not your guy. But if you just want some, you know, someone to pay the highest price, I, I never hear anybody talking about how that is their strategy. But at the end of all of these processes, the only, I think the only, you know, maybe Tiger has done a lot of that in, uh, the late stage venture capital world, along with a couple of other, but you really don't hear that sort of unabashed approach to being, to paying a really high price or paying the highest price as the approach behind anybody who's doing lower middle market m and a private equity investing at the end of all of these processes, to the extent that a deal is getting done, somebody was the highest bidder, and if they didn't win the process, it means something other than price is, is super valuable to the business owner.
Speaker 1 00:11:53 If the search fund is never gonna be the highest bidder, what are the things that they, what's the currency? What is the alternative currency? And, and how do, just how do you think about that and how do you cultivate that currency and help the, the search fund searchers that are in, in the Peterson portfolio cultivate that currency and and learn how to create that currency.
Speaker 3 00:12:11 Yeah, that would be a pretty wild strategy to lead off. <laugh> in l o i we will be the highest bidder, right?
Speaker 1 00:12:18 If whatever they pay plus another half
Speaker 3 00:12:20 Plus a dollar, yeah, <laugh> price is right. You're right. We, it's not as explicit as that. I do think there are some hints. One of them is so in a process, I have never seen a searcher win against a strategic. So if the, if a strategic is in the process, we've never seen a good outcome there because the delta between what a searcher can offer and what a strategic can offer is usually just too wide. So I guess one would be who else is in this process? And generally you can tease that out from the broker. It's their kind of, it's their benefit, right? To kind of let you know the types of other folks around the table. That's one. Two, you kind of have to deduce it. So generally speaking, if you hear something like, yeah, the owner's not very interested in enrolling any equity, the owner, yeah, they're somewhat open to a seller note, but, but really that's not the preference.
Speaker 3 00:13:11 You know, there, there are some hints that you can pick up that says, oh, the owner's actually not really interested in structure in this. Right? Those are usually pretty good tips that they're looking for. Some headline price three would be, I have a, usually have a very frank conversation with the broker. Here's how we're thinking about it. Here's where comps are, you know, we've done kind of a gone back survey with a bunch of my other partners. It's between these two fuel goalposts. The banker might say, yeah, you know, that's in range. The banker might say, that's nowhere close. If you hear that's nowhere close, I generally suggest to end it because you're just gonna start burning your time. But if they say you're within range, they're, you have to trust them. And so those are the, those are kind of the, the, the three main things. Who else are you competing against? Is the seller open to any sort of structure? And has the banker provided any crumbs as to what the process could look like in terms of price?
Speaker 1 00:14:06 I'd love to hear a little bit about the step two emotion that you guys coach, which is all about getting in front of the business owner. How do you figure out how do you do that? How, you know, in a broker led transaction, there's a lot of variability in broker processes. And when we talk about brokers today, we're not talking about full fledged middle market investment banking operations at Harris Williams. We all know that those are bulletproof processes. We're really talking about a derivation of that process. So, you know, what are the ways in which, uh, the brokers allow access to business owners and you know, what can, what do some of the best search funds do? Well there?
Speaker 3 00:14:42 So you're right, comes in very different shapes and sizes as in terms of processes and brokers. And I've seen brokers just put up a full brick wall, you're not gonna get a hold of them. You know, it's, it's very much an art more than a science. Sometimes if you try to do things like LinkedIn message the owner, figure out their email via some of these different databases, you, you, the banker would get upset because you're trying to circumvent them. So it's a dance there. I really have seen searchers really lead with that. So in other words, right on the first phone call with the banker, look, what's really important for me is, is that it's a two-way street. And that I get along with the owner, part of the value that I bring is flexibility and structure. I'm very interested in the seller owning, rolling a portion of his or her equity into the following deal. In order for that to be the case, I need to figure out who this person is. Is there any way I can chat with them, uh, visit them, zoom with them, whatever. I really do wanna get a sense for them, because that means a lot. And that's true, right? You need to get a sense for what you're buying and at this end of the market, right?
Speaker 1 00:15:45 And then you'll just have some that say yes and some that say no. And the broker just essentially spends their time according to how, how that answer comes back to them. Yeah.
Speaker 3 00:15:53 And I think it, it's a decent heuristic, right? If the broker says, no, the odds that you end up winning this thing probably fairly low because we're working off the, the kind of the, the macro belief that you are going to win because the owner's going to push you through. And if you can't get in front of the owner, you're sort of d o a, you know, in the beginning. So
Speaker 1 00:16:13 Do you feel like if you're able to get to the owner in these broker led processes, then then you have a shot at winning the deal. And so at that point, let's say we're at that point in the funnel, now we understand all of those dynamics about how the process is gonna run. Where does it go from here in terms of deliver driving towards a winning outcome? Does at this point it become just che chemistry and trust building process, which is just specific to each business owner, specific to each search fund? Or is there something else that's more mechanical or repeatable? Or is it just at this point like a pure dating game and chemistry and trust are really what's gonna win the day or lose the day?
Speaker 3 00:16:54 Yeah, I think you, you have to have the chemistry and trust and that is developed organically and it's sort of is owner by owner. But there are a couple things that I do think are a bit more mechanical and at least something to have in your head as you approach these conversations. I think like anything else in sales, it's what are they solving for, right? Like, like really get into that. I know you've built this business for 25 years, you know, you have a son. Is he interested in staying involved? Nah, he's not. He has, you know, another passion. Okay, well what about you? You know, is this sort of one of these things? You've done your work for 25 years and you're gonna just wash your hands and see you later. Or do you wanna still be involved on the board, for example, for a year?
Speaker 3 00:17:36 Do you want to still own x, Y, Z relationships? Like what is a, if you're just totally king for a day, what does your day look like? Post-sale, right? And figuring out how your, the form of your offer can follow really what they're solving for. And I think that kind of oftentimes you get beat into this pattern of like just kind of staying high level with the owner and not really getting into it. And I think that extra click is super important regardless of the trust or, or chemistry, which it, which are sort of table stakes.
Speaker 1 00:18:09 And at that point the owner is beginning to either decide whether or not they wanna pursue this buyer, sort of independent of a variety of financial considerations, is sort of where the idea there. Yeah.
Speaker 3 00:18:22 And sometimes that's just structure, right? Sometimes certain buyers won't allow for the owner to roll, won't allow for them to sit on the board, for example, who's strategic, right? They may not. So, so yeah, you're trying to figure out can you differentiate in this process that sometimes on structure flexibility and sometimes on, do they like you, do they trust you that you're gonna take care of their employees? Do they trust that you're not gonna change the name, that you're not gonna repaint all the whole building with different colors, like right away it matters to a lot of these owners. Just to give you a sense. So the average business that our searchers acquire has been around for 27 years on average. There's a lot of history there and a lot of owners wanna protect that. So if you can find kind of the key that unlocks that part of their willingness to sell that usually is, is the differentiator in the process. I'd
Speaker 1 00:19:18 Love to talk a little bit about, you know, one of the differentiators that has arrived in private equity has definitely been more specialization in the last 10 years, certainly in the last five years. You know, you've seen the great majority of lower middle market private equity investment funds or even pretty well capitalized, repeat independent sponsors go from typically having a generalist industry agnostic elevator pitch on who they are and what they do and go to a couple of industries or a few industries where they represent that they tend to have a lot of specialization. Sometimes that's true, sometimes maybe that's window dressing, but there's been a real move to differentiate through specialization at the industry level. And I'm curious, is that trend taking hold in any way in, in search funds and is that a credible source of differentiation in these processes? Or is it less impactful than some of the differentiation techniques that you've been talking about so far?
Speaker 3 00:20:20 I would say less impactful off the bat, but, but I also have seen that happen. So searchers because they were in the health group at McKinsey are starting to say the healthcare group at McKinsey say I'm focusing on healthcare and within healthcare this specific vertical, because I did, you know, multiple cases or consulting projects while I was at McKinsey working on this project. And so I know where some of the low hanging fruit could be be that is common or becoming more common. But really, you know, what, what you don't have, which makes it less credible, are the case studies of I have done this at this business, right? We have invested at, you know, why in, in why industry? We have a board member who fits this mold perfectly. So I guess the short answer is I have seen the specialization, but I don't think that is a bigger differentiator than just the sort of trust in chemistry and flexibility that, that you have with a seller.
Speaker 1 00:21:16 Are there ways that you guys think about, since trust in chemistry is so important, are there ways that you are incorporating the knowledge that's so important into the way that you evaluate searchers or the way that you coach and develop them? Is there, you know, are there personality tests? Are there, what are the techniques, you know, because trust and chemistry just seem like very elusive concepts. Everybody knows they're important, but there's not necessarily a lot of clear guidelines around, okay, how does that, how does one create that trust? And how does one determine chemistry? Or how does one, you know, determine compatibility? Right? And I'm curious whether or not there's any, anything state of the art or anything in the world of science, relationship science, evidence-based research that can get incorporated into the process and be helpful either for searchers or for, you know, search fund investors that are evaluating searchers.
Speaker 3 00:22:07 Yeah, I don't think we we're starting to venture into the nebulous world of emotional intelligence. I don't think we're alone in trying to figure this out. I have seen some searchers do post kind of personality test outcomes in their P P M, which I think is a very cool idea. We're starting to experiment with things like that. You know, really for us, there's only so much you can gather from a person on a phone call on a zoom. Certainly we do reference checks, right? And if there's some pattern of a positive or negative examples of emotional intelligence that usually will surface if you talk to enough people. But we are still in figuring that out. I will say one thing that's been really helpful for us is just getting to know these searchers for an extended period of time. And I know this is the concept that you are curious about is like, where is search going?
Speaker 3 00:22:55 Right? But we're on campuses all the time and talking to different students who have an inkling for search, there are different student clubs on campuses. And so getting to know someone over their M B A one year, maybe doing an internship over kind of another three months by the time they decide whether they should search or not search, you know, we've known them for year and a half, two years. And there's a lot of data, uh, that you can collect on a person, even though it is kind of nebulous over a two year span. And you can get a feel, get a feel for that.
Speaker 1 00:23:27 Well, maybe we should talk about like the future of search and the talent pool that that search will draw from within the academic realm. It's sort of been, you know, only MBAs. Do you see that expanding? Would there ever be, would it ever be a good use of time for the Peterson search partnership to go and meet the guys at the Stanford Law School or at the Stanford Medical School or, you know, Stanford Masters in engineering programs? Do you see there being an expansion of graduate school talent as credible or, uh, let's start there. Uh, there's other places that I want to go in terms of diving into talent, but let's just start with the academic realm. Do you see other, other pools within academic communities?
Speaker 3 00:24:06 Great question. I think what you first will see is an expansion to, you'll, you'll see a horizontal expansion across the country in other schools before you'll see, for example, going to the school of engineering or medical school. I'm not certain that folks who go into medical school would select to be searchers, right? Those schools do somewhat self-select and maybe there are instances like law school could be a really good one where that skillset could help you in the business world tremendously. But again, I don't really have a feel for what percent of a law class would actually even be interested in search. I don't know. And, and, and I know that it's expanding, will keep expanding nationally. 'cause we've already seen it happen in the past year or two. You know, a different class pops up, a different club pops up. We're seeing an international expansion that's been particularly wild in the last call three years. And so yeah, I, I do think the denominator of searchers is going to be growing a lot over the next decade for one words just getting out. But for two, I really do think with the baby boomer generation starting to go into retire or sell mode of their businesses, there'll be a huge supply and demand imbalance. And I think what you'll see is the demand, meaning the actual searchers or the people at the end of the market start to grow to match that supply because it's, it's gonna be growing exponentially.
Speaker 1 00:25:32 I interviewed a successful searcher who was in my graduate school class a few weeks ago, and you know, despite him having two years of McKinsey and, and two years of private equity under his belt, he was just adamant about the importance of like selling your way through the deal sourcing and the deal winning process. Very unapologetic and very high conviction about just like sales being the sales process, being fundamentally what you're engaged in as a searcher. Just constantly selling, persuading the owner, persuading the broker that you're not gonna be a bottom feeder and a waste of time for him to bring it to the process, whatever the case may be. Just constantly in some form of sales dialogue, you know, against the market and against the market's forces. Do you think that there's an opportunity for the whole sort of pool of sales leaders and sales management, you know, around the country independent of business school, independent of pedigree to become the most important category of searchers that sort of fall out of the Stanford or the Harvard or the M B a, uh, program? Like is that where a lot of the baby boomer demand could, could be met with new search or supply?
Speaker 3 00:26:45 I wholeheartedly agree with your friend and oftentimes, you know, around campuses and things and presentations and people say, well, what do you look for or how can I best prepare? And I usually say, look, if you walk into a room and there's a phone there and you just need to dial a number and talk to the person, the other line, if you're staring at that phone and that's not giving you an excited nervousness, but an actual fear, you may not be cut out <laugh> for the early days of search because that's essentially what it is, right? I would say to your question, if you zoom out and say like, what is search? And I often do this explaining it to people who, who don't know what it is, and they always say, well, that's insane. And I'm like, but yeah, that's, it's absolutely insane. You're going out pounding pavement, cold calling, finding a business, finding an owner, telling the owner that you are the person who can take over their business on a cold call doing diligence, basically setting up little private equity fund, doing diligence on a deal, getting the capital, acquiring the business, and then jumping into a business that you likely don't have a ton of experience in, and improving it with people who've been in the business for years.
Speaker 3 00:27:53 That concept is insane, right? And so I would say sales is one of the most important. It is absolutely the most important in the search phase of it. And then, you know, you can get into a bunch of arguments over how important is it in terms of leading the business. I still think it's very important, but it takes more than just sales, right? Because the, the different processes of the actual, or sorry, the different kind of stages of the process all require different skills, but sales is overlapping.
Speaker 1 00:28:22 Is that a realization that's been around for a while in terms of backing a searcher or is that something that has been more appreciated as maybe like the private equity category has become more competitive and sales, I mean, is that a skill that's increasing in importance or has it always been critical and there really hasn't been much change? Yeah,
Speaker 3 00:28:43 I think when we say sales, we sort of fold it into the evaluating emotional intelligence, right? Like I, I think many of the best sales people are highly, you know, high EQ type people because such a big portion of being a good salesperson is really understanding, communicating, clearly relating, finding the chemistry with the other side, which are all overlapping with sales. And so we don't really specifically filter for it. I would say it's a check in the kind of, in the plus column if it's, if that's where a searcher comes from experience. But really what we're interested in is the emotional intelligence piece.
Speaker 1 00:29:17 Well what about P S P? I mean the, the investment effort at Peterson is about four plus years old on a dedicated basis, is that right? Yeah,
Speaker 3 00:29:27 It's a, it's a little bit of a,
Speaker 1 00:29:28 I know that, I know that, I know I guess Peterson Partners has been investing for decades, right? In search funds and then it was formalized and codified most recently through the Peterson Search Partners investment effort. Is that a
Speaker 3 00:29:40 Better correct? Yeah, that's fair. Yeah.
Speaker 1 00:29:41 Okay. And so that's what is sort of roughly four to five years old, is that that fully formalized, fully dedicated effort to partnering with searchers.
Speaker 3 00:29:50 Exactly.
Speaker 1 00:29:51 Okay. I guess the reason that I was asking that is, you know, I wanted to hear just, I wanted to hear you zoom out on what's changed and what's stayed the same. How have you guys tried to get better over that period and, and what are some of the, you know, that's a effectively a four-year-old startup in its own way, right? And every startup has multiple changes along the way, multiple pivot points, including startup investment efforts. What's changed and what's stayed the same?
Speaker 3 00:30:15 I'll do Matt, when, when we first started it, the kind of credo was always searchers first. What we kind of realized was, well, if you don't have the best searchers, you won't find good deals, then you won't be able to raise the capital from LPs and you won't have the good returns. And so the whole process begins and ends really begins with finding the best searchers. And so, you know, I've said, and I actually mean this, I would probably hang up on an LP if a searcher was calling me because it's, that is the whole, our whole universe is structured around that. So then the kind of derivative of that is, well, how do you get the best searchers, right? And our belief is, and I really learned this from Joel, you don't necessarily tell them what to do, but you remove all of the hurdles in their life so that they can, or in their, at least their work so that they can flourish, right?
Speaker 3 00:31:08 And actually kind of use the skills that you've bet on. So what that means is constantly going to our searchers and going to the market and saying, what are your pain points? Hiring interns, it's a total pain, right? Finding them, they churn when one group churns, I spend so much of my chunk of, uh, chunk of my time reeducating this new group. So we all got together and said, okay, well how do we solve that? Right? How do we help that? And we have done various things to help for that. So I think the overall kind of credence of searchers first has been the exact same. I think in like any other kind of startup as you scale, there are challenges with that and growing the team and finding the right people and we think we've done that. And so I would say the day in day out work is about the same. The team looks a little different, I think, in a very positive way. And then the mantra is the same, right? Searchers first beyond all else. What
Speaker 1 00:32:00 About, do you guys ask yourself questions about where the best search talent could potentially come from and, and whether you're missing, I'm curious sort of, I guess whether or not, you know, there's just a huge pool of search talent out there that doesn't know it's out there. Maybe we could talk a little bit about that before doing that. Maybe like, just, could you just frame that by just talking a little bit about where do the searchers that you guys back come from? Just either in percentage terms or numbers, terms, just,
Speaker 3 00:32:29 Yeah, so there's kind of the schools that have been around doing search for a while, H b s, Stanford, Wharton, m i t, slunk, Kellogg Booth. Those types of schools have, have, have been doing search. They have like pretty, pretty formalized ecosystems. They have, you know, student groups. They have lecturers and adjunct professors who were searchers at one point. They have classes dedicated to. And so those are very known quantities for us. And, and I would say close to 95% of our searchers come from those schools. To your point on kind of the other searchers out there, I, it's funny, I, I recently read an article about the World Surf League and something like 98% or 98 of the last a hundred champions have come from Florida, California, or Hawaii. Right? And I started to think, and I'm like, is there possibly an amazing surfer in Ohio who just has never surfed before?
Speaker 3 00:33:25 And then of course that got me thinking about search, right? Like the answer is absolutely like, there, there just has to be. And I think that back to those schools, the reason that we focus on those schools is because the formalized ecosystem, it's a very known quantity once you arrive on those campuses that search as an avenue, right? At many other schools, you don't even know that it exists until you hear some soundbite or a podcast like this or there's happens to be a professor or lecturer at the school that has done it before. So the the short answer is yes, there must be, and I do think over the next decade or so we'll see an increase from all sorts of M B A schools.
Speaker 1 00:34:02 What about structure of the relationship before the searcher and structure of their ownership opportunity? Do you see interesting things changing there? Has it been more fluid there at P S P? What can you talk about in the context of just how the ownership opportunity has changed or stayed the same for top searchers that you guys would compete to back
Speaker 3 00:34:22 There really hasn't been a major shift, I would say.
Speaker 1 00:34:25 Is the prevailing structure still sort of a third, a third, third and a third? Yeah.
Speaker 3 00:34:30 Yeah, that's right. I would say some searchers in much bigger deals might vest a little bit less in the first bucket because it's just such a big deal that, you know, they shift some of the economics out to performance instead of the early day zero vest. There hasn't been, you know, I, I guess one of the main things that has it's become more frequent in the last couple years is changing in out years from an I R R basis on the performance vest to an M O I C. Obviously it's a, it's a great business year, seven or eight might be cash flowing, but if it's cash flowing the same amount over the course of later years, the I R R goes down and then searchers feel penalized for that, which I think is totally fair. And so what we've seen is a flip over to M O I C after five years and then that bracket kind of grows at 20% over the kind of over the out years. We've seen that quite a lot. That would be kind of a more common change, but overall it's basically the same.
Speaker 1 00:35:28 So do you think that you guys, would you contemplate obviously in with no guarantees, but do you think that the evolution of talent for the search market would occasion like a reflection by you or by other search fund investors to, to go beyond the, the halls of, of top business schools?
Speaker 3 00:35:47 Yeah, I think like any other, I've actually paid close attention to what's the history of kind of venture, right. And I, I think it might end up looking sort of similar in terms of the curve of growth in out years. Like I don't know what search could look like in 20 years, but I do know that what venture used to look like and what it looks like now are wildly different, I believe with the amount of capital that's been raised and the kind of network effects of every searcher that you add might be 10 or 15 more people around the country learning about search, right? And then you kind of, your network affects that and you're at a pretty sizable number pretty quickly. I think like podcasts like this and conferences we're seeing sprouting up and virtual conferences in all sorts of different parts of the country. I, I do. And I think we're prepared to widen our purview over the next couple years.
Speaker 1 00:36:37 And what about the legacy of sort of the search fund investors not being the highest bidder. Is there a world in which search fund investors can be, you know, sort of at the market clearing price, so to speak, in a financial way as opposed to a chemistry and trust way and have all of the math still pencil out? Like does, does that have to be part of the, is that reputation and narrative around, you know, a search fund partner? Is that, do you feel like that's bundled into the economic rationale behind the whole sort of search fund endeavor? Or can that change as well?
Speaker 3 00:37:12 Yeah, I can't speak for the whole <laugh> group of investors obviously. I, I would say I do think it will become, it will stay in important of buying a deal for a search fund to buy a deal if that's in the market or buy a company that's in the market. It's one of the only, it is really the only thing that you can control heading into a deal, right? Heading into the acquisition is the structure and the entry price mostly first time CEOs, mostly in industries they've never worked in before, sometimes slash usually in geographies they've never lived in before in a role they've never been in before with people they've never really met before. Like in terms of the control, the controllables, that is one of the things that we think is vitally important. And, and we've kind of looked back at our data and said, if you look at the proceeds, the better deals has it, was it been from, it's been from EBITDA growth or multiple expansion, a lion's share is multiple expansion. And I think that's a crucial part of our underwriting and I think should be vitally important to a searcher kind of heading into an acquisition. So might it change? Yes, because the whole tide of multiples might continue to grow up or, or keep increasing, but I think it is important that search funds remain not the highest bidder.
Speaker 1 00:38:26 Right. And the multiple growth you're saying is for reasons other than EBITDA growth?
Speaker 3 00:38:32 Well, what we said was, if you looked at strictly what part of the, what percentage of the proceeds from a sale came from the multiple expansions, so you just hold EBITDA constant and compare it to what EBITDA actually was. A huge portion of it is the kind of jump that you get from the micro cap world to the lower middle market where multiples are so much higher than what, what searchers are entering at. But
Speaker 1 00:38:56 If you were to look at some of the best performing deals and say, okay, if we played, if we paid 10% more, if we'd paid 15, 20% more, it doesn't really have a very big impact, would it?
Speaker 3 00:39:07 It doesn't, it doesn't. And in fact, I've heard a search fund investor say he took kind of his top 10% performers and his worst 10% performers and he put 'em all up on a whiteboard and he said, if I had paid 20% more at entry or 20% less at entry, would it have impacted it? The answer is no. And the problem is, you know, you can't predict which ones are gonna be winners or not. And so again, back to the what can you control at ad acquisition entry price is basically the one of the only things that you can, and so from a overall thesis perspective that I think that's gonna remain the same on a relative basis.
Speaker 1 00:39:43 One thing that I'd love to hear before we wrap is maybe just have you, you know, give some advice just shooting from the hip to answer the following question, right? Which is, when I grow up and, and become a professional, I wanna be a, I wanna be a small business owner, right? What's your advice for that person? I always hear people in interviews and, and other things talk about, I'd love to come and work at this company or that company, and then after that I'd love to start a company of my own. You don't hear a lot of people think about and talk about their career as well. One day I'd like to go and acquire and run a company. You don't hear a lot about that. Usually people say, I'd want to go start a company of my own someday, like a de novo, you know, startup, whether it's a tech startup or not, that's what you sort of hear from a lot of young college grads and and, and stuff like that.
Speaker 1 00:40:25 Or I hear it, you know, when I'm interviewing young college grads, but if someone was to say, I, I don't ever want to go and start my own company, but I'm graduating from undergrad and I just wanna work backwards from taking over a small business and be, you know, and having that be my path. What, what kind of advice do you give to, to that kind of profile of person who has that kind of clarity? What should they do in the first five to 10 years of their career? Put themselves in a position to be a great search fund or to just be a really well qualified person to take over the, the operations of a small, medium sized business? Yeah,
Speaker 3 00:40:59 I mean, I'm always been a fan of some version of formal training, if that's with a big corporate group or a bank or a law firm or an accounting firm. Just to sort of get your bearings of one end of the market and say, you know, if you feel very allergic to that environment, <laugh>, you might say, well actually small business I, I might be a good fit for. But I do think there's a lot of value in learning, like how do organizations work after they've matured, right? Like how do, what are the different functions? Like who are the people in those functions? How do those people interact and how do those functions interact? And, and I think there are a lot of good takeaways even coming out of undergrad. How do you write an email <laugh>, like a formal business email? How do you work in Excel?
Speaker 3 00:41:44 How do you come up with a succinct presentation? I do think those are valuable. That said, I, you know, I think you really have to love people. I think you have to find roles where you're customer facing. I think figuring out what you naturally gravitate towards, right? If you are not super fired up about the team meetings or you're not really interested in the kind of offsites type stuff, that's the stuff that's important. And small businesses, because it's such a small team and you have to get along with everyone from a personality standpoint, really when you boil it down, it's about kind of those relationships. And so being honest with yourself, like what part of my job do I really like? What part don't I like? And the people part of it. I think it's a really good start on your way to becoming a small business owner.
Speaker 1 00:42:29 Well Max, maybe we should leave it there. This has been a ton of fun. I've learned a ton. Thank you for making some time stepping away from all the searchers that you backed <laugh>. I'm sure if one of them had called during this podcast, you probably would've hung up in the podcast. No,
Speaker 3 00:42:41 I probably wouldn't have. Not on you. No <laugh>,
Speaker 1 00:42:43 This has been great. I look forward to seeing you later this year, hopefully. Thanks for making some time. I look forward to getting this podcast out to all the listeners. A lot of good stuff.
Speaker 3 00:42:51 Really appreciate it, Peter. Thank you.
Speaker 1 00:42:59 If you enjoyed this episode, check out axial.com. There. You'll find every episode of this podcast as well as our recorded axial member round tables, some downloadable tools for deal makers axials quarterly league table rankings of top small business acquirers and investment banks, and lots of other useful content that we've created over the course of time. If you're interested in joining Axial as either an acquirer, an owner considering an exit, or as a sell side m and a advisor, you can get started for
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