The Shifting EtA Landscape: The Rise of Self-Funded Search with Royce Yudkoff & Richard Ruback

0:04 hello and welcome everyone I'm Peter lman and this is masters in small business m&a this show is an ongoing exploration into the vast and undercovered world of small business m&a where we interview both The Proven and the emerging owners operators investors and advisers 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

0:32 business m&a this podcast is produced by axiel an online platform that makes it easier for business owners and their m&a advisers 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 free at axle.com hey everybody welcome back my name is Peter lman and this is masters in small business m&a I am extremely excited to

1:04 have two guests on the podcast today Royce yudof and Rick rubach they are the joint authors of the Harvard Business reviews guide to buying a small business active professors at HBS and just a fantastic set of people for me to have the the privilege of interviewing thank you both for the opportunity and it's great to be with you both it's a pleasure to be here yeah thank you for inviting us I want to get into ETA and spend almost

1:33 all of the time on ETA but just very quickly would you would you all just and Royce I'll start with you just take us through the coursework that you're doing right now in the entrepreneurship through acquisition category at at HBS and and Rick you as well U I just want to make sure that there's a little bit of context on the classes that you're teaching related to the topic sure I'll I'll begin and Rick you know

1:58 please jump in and I'll hand the ball off to you in any case but Rick and I really teach three classes all of them are in hbs's second year which is when our mbas get a chance to elect what interest they have and what courses they want to take in the fall we do an overview of the small business and acquiring small businesses so we're kind of defining the market the opportunity and at a high level how you go about

2:24 buying a smaller firm and then some of the big operating challenges that manag face during that course students start to form an opinion about whether this career is for them and for those who are serious about it they will sign up for our spring course which we call Eta and which is a stepbystep walkthrough of each step in buying a small firm so you know with Equity raising and debt raising and how do you source and how do

2:53 you diligence and we bring in experts from each phase of that to talk directly with a student so it is you know think of it like teaching someone to assemble a bicycle it is intensely practical and then for a small subset of students that are actually totally committed to doing this and getting started now we do a small seminar on how to source which is of course the first step in searching for a business to buy and so that's a

3:18 very practical focus on that first step let me just pause there Rick would you add modify I think that's a great description the only thing I would add is that the fall course is kind is a traditional HBS casebase course 28 cases lots of guests I think we had guests for virtually every case last year right I think that's right right yeah as is our normal practice the spring course is what we call the field course so there

3:46 we try to bring the field to the Harvard Business School which is located on Soldiers Field so we always say we're bringing the field the Soldiers Field but you get the idea and we have I think this year planned about 140 guests is that right Ro something like that that's right it's a it's a crazy big number but you know we have a few days in which people we bring real investors to hear student pitches and we have lots of students so we need

4:15 lots of investors so that explains a lot of the guest and one thing I just add to Rick's point about the guests is you know we do this for two reasons one is Rick and I are very practical about what we want to teach the students and so bringing in people who really do this at adds to that practicality of lessons but the other maybe less obvious reason I have a guessed is the most of our

4:37 students are looking at this career and saying is this for me can I do this do I want to do this and Rick and I have found there's no substitute for putting in front of them someone say who has searched and bought and run a small company and I you can imagine our students are looking at that person and asking those questions to themselves can I be that person do I want to be that person so those are the joint reasons

4:59 Rick and I have this heavy focus on guests in each class so the 140 guests in the spring that's over the course of the semester or that's part of some big powwow during the semester no it's over the course of SE of the semester I think two weeks ago we had five guests on how to fund the search people doing all kinds of different way people Searchers who had purchased businesses talking about the different ways they funded

5:26 this search and we had you know sort of the five different strong models represented last week we had an investor pitch day and we had about what was the exact number I don't know 35 35 guests yeah it felt like a lot of people yeah all smart brilliant a delight to be with but just a lot to manage it goes without saying that the ETA category has way more interest today

5:58 I was in graduate School 2006 to 2008 there were a handful of guys from my class who went to start a search fund but I could count it on one hand and today it's a much larger number both there at HBS and lots of other schools and then it's also a phenomenon that goes beyond the NBA which is something that all three of us are really excited to talk about today I would like to just get your

6:27 perspectives on why this is happening like why do you think the interest is growing is it just a classical expression of sort of you know sort of Supply meeting demand in terms of silver tsunami and you know and and the sort of opportunity and it do you guys have some point of view on just why the category is growing and expanding both in the NBA realm and in the non-nba realm in the in the way that it is and what is behind

6:56 that you spent time on that Rick would you like to start on this sure I one of my favorite sayings is nothing succeeds like success and I think what we've seen over the last 15 years where Ro and I've been teaching these courses is that as more and more students elect this career path subsequent students look and say wow that really worked out for that person and that person was a lot like me that person was a Navy veteran that

7:22 person was an engineer that person you know had this background that person had three kids I have three kids what whatever it is but there are enough people now having done this that people can look and find role models and say wow I want to be I I really like the career path that this person picked or I really like the career path that that person pick so I think that's a lot of it it is becoming

7:49 mainstream one of the things we do in our spring classes we have a friends and family night where we ask the students to bring their friends and family to class and we do that on Zoom we usually have 250 family members or you know 150 family members in addition to our 100 students and one of the things that has changed over the Dozen Years we've been doing this class is in the beginning we got questions like you know my my

8:21 child is spending the day in their pajamas steering at their computers how do I know when it's time for therapy you know what are they really doing why don't they get a real job and give us grandchildren which is what their goal should really be and and now we have questions about financing and questions about wealth and questions about how busy they'll be and and those sorts of questions so what I think has happened is that the career path has become

8:54 legitimized in the past when you took a job at a major consulting firm nobody asked you why you were doing that or whether you were suffering from some mental or social illness in the past if you said I'm searching people would just say GE I wonder what's wrong with that person and and and now that's gone that that that idea that you're being a Pioneer why you doing that I I think that's gone Ry anything that I

9:24 have not a single word to add to that I think that's exactly what's happened I would add by the way the fact that the job market has been a little more difficult for NBAs gives them the opportunity the space to consider this in the past if you go back when the job markets hutter and the consulting firms hire summer interns to full-time jobs in September and October they don't really have time to think about this problem ours is a seconde course they

9:56 may learn about this and then say oh wow I've already sign my offer what do I do and HBS has pretty strict rules that if you sign an offer you actually have to fulfill your obligation so I think that market the job market has allowed more people more space to think about their opportunities deeper into the fall and spring which I think you know I know the students don't particularly like that but I think it's you know it's good

10:27 right better to get to the right answer there's about 900 to a th000 students per class at HBS if I'm not mistaken unless that's changed and it sounds like you guys are teaching about 10% of the class right 90 to 100 students is that is that well more than that in in the fall we have two soldout sections and we squeeze in about 97 or 98 Souls into our classrooms we just don't have any extra seats in

10:58 our class so that's that's about 20% of school yeah a little more and then and we could do more I think but there's only two of us and we have a similar kind of thing in the spring Al the spring course is an applications course so we get somewhere between a third and a half of the people who took the fall class electing to take the spring class this year it was more than half which was

11:25 unusual well it's great it's great context to just hear a little bit about how the school is approaching the category and we'll spend some time talking about the NBA topics but I also want to spend a lot of time on the big one of the big Ideas which you guys are excited about which is how this category has completely escaped the NBA and and has you know its own legs outside of elite NBA classrooms as well so we'll

11:50 spend some time there I'd love to just get into the the primary areas of change as you all are experiencing them and witnessing them in entrepreneurship through acquisition we'll start with financing just because that's what Roy that's what you mentioned as as one of the topics before we push record and we'll start with you there's a lot of a lot of change in just the the available financing types for the for ETA and for the transactions sounds like you feel

12:22 like that's happening both on the equity side and on the debt side it's not just happening on one side so tell us a little bit more about that sure happy to you know Rick and I have been working this territory for 15 years and one of the things that has just been striking is how much easier and how many more choices Searchers have to raise equity in debt so if you go back you know even a

12:46 decade when a Searcher found a deal and put it under a letter of intent one of the things they had to do is scramble like mad to find a bank that would provide senior debt financing on that and would be comfortable the whole idea of searching and someone who didn't know the business and was young running this and because these loans are small that usually meant you know you had landed in some territory where that business is

13:09 and you'd have to go to all the local and Regional Banks there and see see if you could get a bank commitment before your letter of intent ran out what's happened over the last decade is there are now multiple banks that have search departments and they follow Searchers naturally nationally so at the start of your search you connect yourself to them you keep them updated on your search and wherever that company is you'll get several banks that understand search and

13:36 are willing to make loans anywhere in the country to a small firm bought by a Searcher it is a it is a huge advantage in debt financing and on the equity side when Rick and I started doing this the equity financing for funded searches where a Searcher actually raises a search fund and has their costs covered while they search there was a small group of mostly High networ individuals who did this part-time and it was Clubby

14:02 and small and what's changed about that is that there are numerous institutions which have jumped into the field what you might think of as Tiny private Equity Funds that focus on backing Searchers and by the way I think Rick would agree with this there are far more sources of equity capital for funded search than there are high quality Searchers so this is a golden moment in terms of raising equity for Searchers and then lastly in self-funded search which we'll talk

14:31 about later where you just go out on your own nickel and look for a company and get an SBA loan now we're seeing the same phenomenon where what used to be everyone had to had to come up with their own club of investors they're now recurring investors in self-funded search that you know you could go to lists and and work your way down and all these people routinely invest in F in self-funded searches so that world of

14:54 access to Capital has improved massively Rick would you add anything or change anything there I think that's all exactly right I think it has become much easier to fund transactions in the small firm space than it ever was before and I think that's to everybody's benefit the sellers the buyers certainly all those that benefit from having an active and vibrant small business Community one of the things I think is worth mentioning is that the people who are searching have

15:26 changed they're no longer a particular you know there was a time when almost all Searchers were men no longer true there were a time when almost all Searchers were white no longer true and what we're finding is that searching is broadening Beyond just a select group of people and is now available to a much broader set of students which is something that I think is really terrific totally agree with that and

15:56 I think that's also part of the the self search category as much as it is within the NBA realm I just want to I did want to stay on financing for a bit so on on financing do you all have any point of view on just sort of how the SBA could make changes over the next few years there seems to be some interest in having the SBA sort of index the sizes of the loans and have

16:27 that change in the way that you know stuff gets indexed to inflation and in other government policies but are there other areas related to the SBA and just the sba's relevance to to to search and to self-funded search in particular that you guys think is either interesting or is potentially going to change the way that the market works or H or has changed the the the breadth of the category first of all I think one of the

16:54 issues right now is that there's still a lot of people who are interested in buying their own small company that don't understand the SBA opportunity one of Ricks and my students memorably said that every American has the god-given right to borrow $5 million from the federal government to buy their own business which was sort of an interesting turn a phrase it's actually not really god-given it's government- given but it's an amazing opportunity to borrow up to 90% of the of the purchase

17:24 price of the business often a chunk of the remaining 10% is taken back back in a seller note so you don't have to be rich to do this and and so I'd say the first thing that should change is there should be a more widespread understanding of you know the commitments you make and the opportunity you have in these loans but I would just touch on two things you know that the SBA could address one is Congress caps

17:49 the limit of the loan size and this loan size has stayed unchanged for like 20 years so there's clearly an opportunity to go up you know inflation adjusted and I I've never calculated yeah exactly but to be it there's no reason the cap shouldn't be at 10 million for example that's a congressional issue and then you know the SBA takes a bit longer than a than a conventional loan and I think Searchers just have to be good upfront

18:15 communicators with sellers it's not a huge amount of time I mean it might if a conventional loan takes 60 days this might take 90 or 100 days if if well processed you just have to communicate that to the seller so they're following the milestones too but it's a challenge Rick would you add anything to the kind of what the SBA could do different that would I think a of course a higher limit and a smoother process would be terrific

18:41 but I would just point out that there's been institutional adaptation there are entities that help people find the SBA Loans and help get them through the process much more quickly and they'll also help find you secondary financing so if you had a $7.5 million hole most of these Banks or many of these agents what's the right way of calling them they're not intermediaries yeah these

19:13 intermediaries we'll find we'll find you that that line of credit or that subordinated note I would just say one of the other things that a couple of the other things that's really interesting about the SBA one speaks to Royce's first point that people often don't understand it the personal guarantee intimidates lots of people it shouldn't you know most businesses would have to have a

19:44 cataclysmic decline before the personal guarantee ever comes up because there's no covenants the only Covenant is that you actually pay your cash obligations and so it's not like a more typical traditional loan where there's quarter to quarter covenants that are set so that if you fall 20 or 30% you're going to you're going to go ding on the Covenant and transfer the power of that loan back to the bank and and have to renegotiate something what we call the menu of

20:15 misery because none of those things are pretty joyful but in the SBA there is no menu of misery you just have to pay and so people worry about that we've had combat veterans decorated combat vet who were shot at with real bullets in places like Afghanistan or in airplanes and and and they get intimidated by the risk of the small business loan and and the risk of the personal guarantee

20:46 and I I've never seen combat 70 years old I think I'm gonna get out of here without having seen that but I must say I do not understand how you could be more intimidated by the S SP Ba's personal guarantee than somebody shooting at you with real bullets so it seems to me that there's a lot of misunderstanding there people I think are coming around to that but it is a slow process and it's very difficult because these are

21:14 really family decisions ETA is really a family decision and so even if the Searcher understands it it may be that other family members particularly their spouse may find it very scary can you you say more about it as a family decision Rick that I just want to make sure that gets developed what what are you what are you getting at there I think the decision particularly for midcareer Searchers but even for a lot of our Searchers right out of HBS HBS

21:42 has a generally an older class we our typical student is entering students a little over 27 years old many of them are married some have children and so the decision to foro a more traditional job and pursue the ETA path is very much a family decision so we tell our students to to to talk to their families and we spend a lot of time on that issue and you know ETA sometimes requires relocation SP often requires

22:15 relocation a spouses maybe have to change jobs kids are going to have to change schools you may be moving further away from family it's a complicated family decision and I I think Searchers who don't involve their family in those decisions run a great risk that even if they have a great company they could have a miserable life because the rest of their family is unhappy right were you gonna say something no I was I'm GNA say I agree

22:47 with what he just said yeah we know not a lot of Searchers I think I don't think you have to take off you know your second Mitten to count them but people who buy businesses and think that spouse will just get used to living there and it doesn't work and we know other Searchers interestingly who say well I'm not going to relocate my family I'm going to buy a business if I my business has seven offices and I'm going to be mainly

23:16 traveling between those seven offices I want to locate near my family or my in-laws so that my spouse will have a support network while I'm traveling and if a kid's sick and and we need emergency daycare we have a grandparent nearby th those kinds of things I think are very very sensible considerations I mean I guess a traditional career is also a family decision to the extent that you have a spouse but I guess it just doesn't have the open switches

23:46 associated with the search process right it doesn't you know if you take a job from HBS or you take a job in the corporate world you know where it is you know what the salary is you know where your you're going to be located whereas to set off and execute a search you don't know a lot you don't know where you're going to ultimately live you don't know whether you're going to be successful you don't know exactly what

24:09 you're going to be capable of paying yourself you know once you acquire the business it just has a lot more deferred deferred answers that's right and I think I think this is true I don't know this is something I don't know but I think searchers that we've talked to one of the things they report is that the business really becomes part of their family in a way that a career in Consulting does not or a

24:41 career in private Equity does not you know I don't imagine as an assistant professor my my wife and children were deeply interested in my research or the latest programming challenge I had or data collection challenge I had I don't think they really cared about how I modeled things they they didn't offer any opinions about statistical variations or how to appropriately compute standard errors they weren't really interest I don't know why they

25:13 weren't it's very interesting stuff but they weren't interested in that stuff and and I suspect if you're running a business and we've heard it over and over from people the business becomes part of their family I was actually curious to talk a little bit about private equity and the relationship that you guys see between private equity and ETA I I'd like to just you know and Roy

25:45 obviously great to have you as part of this having run a private Equity Firm and started a private Equity Firm and and now you're doing this you know how do you see ETA and private Equity are they going to just sort of run in parallel as these sort of like separate categories that are adjacent to one another is there going to be some sort of Osmosis between the two that begins to sort of emerge if you could see a

26:10 world where the SBA is granting 10 million in debt as opposed to five million in debt the purchase price of the businesses that the search category could go after would become full-fledged lower Middle Market businesses you know I I'm just curious like H how these two you know sort of distant cousins are going to potentially become like much closer to one another over the next five years than or 10 years than over the last 10 years I'll start but then I want

26:38 to turn it over to Rick who has taught Corporate Finance forever and will'll have his own views on this as well I think they're going to remain in parallel slowly slightly growing a little bit closer and I think there are several things going on one is Searchers will buy a small business sometimes they loan it forever but often they'll professionalize it they'll grow it and it becomes of interest to a private Equity Firm because of its size and

27:05 greater professionalism and so you're in a as a Searcher in some ways you could think of yourself as you're in the build to suit business for a lower Middle Market private Equity Firm the reason private Equity firms don't want to do themsel that themselves is it's it's sort of twofold one is these firms are small by private Equity standards you're investing you know of two5 at the high end maybe eight or 10 million and that is just really really small for a

27:35 private Equity Fund that's trying to invest a $500 million fund you're tying up expensive people you're trying to get a fund to work it just doesn't work in their economics and then on top of that it's actually more work because often most often with these search targeted companies not only do you have a big professionalization and growth job but the found CEO is retiring so you the private Equity Firm have to find someone who you can recruit in who will be good

28:05 and who will run that firm the Searcher is displacing that because they're organizing the transaction and then they're running the firm so private Equity firms generally don't want to do this they want to be the buyer of the firm five years later at the next level and when I said they're growing a little closer together it's only because some lower middle byut private Equity Funds will themselves back a rollup and that rollup will buy these kind of

28:32 firms but the Searchers only find themselves in competition there if they're choosing to go into a sector that's being actively rolled up by private Equity firms today if they're not there then they won't see that so so that would be my reaction as to the parallelism of private equity and Searchers but Rick would you add anything or change anything yeah I would I'd add a few things so first of all it really is different between funded and

28:57 unfunded funded search the funded search Community has really gone up market so the typical transaction size last time we looked at the data is about 16 OR7 million with Equity checks at 8 or $9 million but I think if you were to look at more recent data you might see them even higher so when you look at a transaction that's $30 million

29:29 being done by a Searcher that feels like a small private Equity transaction it's not it's not a small search transaction it is interesting the multiples that they pay have also are are also rivaling the private Equity multiples because they of course have to compete for those targets those opportunities with the private Equity firms the you know private Equity firms have been stigmatized on

30:00 occasion completely unfairly Roy of course unjustly unjust all a calumny yeah yeah and so there might be an occasional seller who will say well I really don't like private Equity because you know my aunt stie was in a hospital owned by private equity and she broke her toe and whatever they'll say and But but so there's some kind of stigma associated with private Equity but I think that's fading and particularly if somebody wants to sell their business I

30:30 think they can swallow hard and sell it to the people who have the highest price and the highest likelihood of close and one thing we know about private Equity firms is that once they go through their commitment process the question about whether they can get the capital is is not really a relevant question they might have a question about whether they can get it through their valuation committee where get it through their their approval process but

30:57 once get it through that process there's no question about the committed Capital so I think the the funded search has really gone up Market they paying higher multiples and they're engaged in higher transactions which I think come very close to private equ the smaller end of the private Equity firms they're not competing with KKR they're not competing with a multi-billion dollar funds as Roy pointed out you just can't fill up a multi-billion dollar fund with two three

31:28 even four or5 million transactions and if it's an $8 million transaction you're probably never going to be more than 25% of the total Equity so the net result I think is that it's just impossible for a big private Equity Firm to do what Searchers do but on the up end of the market they are competing on the lower end of the market I think everything that Roy said is true you know somebody asked me I don't know 5 years or so ago after we've

31:59 been teaching this for a long time somebody said to me well you know you were trained as a researcher so now that you've been doing small business for a decade what have you learned and I and I said I have learned that small business is small because everything special about small business investing comes out a result that they're small they're coming in small check sizes and so you have to find a way to minimize your fixed

32:24 costs on the the scaling up of the purchase price among the funded search Community there seems to be a bit of a narrative just around like you know the the very best returns of search are in the rearview mirror maybe now not that the not that they're bad going forward or that they will become bad but I would be interested to just get your perspectives on returns Roy you mentioned it's a bit of a golden era to

32:52 raise Equity if you are a really promising Searcher yourself there's just more C capital in the form of but maybe both equity and debt I think you were referring to the equity then there are great Searchers to back despite a big expansion in the supply of Searchers coming out of business schools and and and mid-career but yeah I remember reading like a Yale paper on on returns and some speculations on returns that you know just maybe clouded the picture

33:20 a little bit on you know the future being as as impressive I guess as the past when you look at you know the Stanford reports on on returns do you think can I sneak in there Roy yeah go ahead R you no please go so first of all measuring so now this is the finance Professor side of me I'm so sorry it's elusive to measure yeah yeah I mean Bob meron who's sort of the smartest person I know in thinking about expected

33:48 returns he would say that expected returns are about the most difficult thing you can measure and and estimate once told me at a dinner I was at MIT and we overlapped at MIT and then we overlapped at Havard so I got to know Bob well he once said that he would change trade all the Empirical research and finance for just one expected return you know handed down from you know Sinai or whatever your religious

34:18 affiliation is so that you could find out what is the god-given expected return you can't really tell it right so I think you can't look at 10 10 years of data and say oh I can tell this is the Golden Era has passed I there's just not the statistical Precision to do that and we're talking about at most a few hundred transactions not not nearly you know if we can't do it on the stock market how could we ever

34:47 do it on on the search market so number one we just don't have the statistical Precision to tell anything number two is again I think this is really going to be different from funded and unfunded and the reason is is something every student knows that we've had that I say over and over again the magic is in the multiples if you buy a business for three and a half times or four times you're going to have

35:15 a great return because you have an eida yield of 25% if you don't goof up the business you're going to have a fabulous return put a little leverage add a little growth it's not how to get mid-30s if you buy a business for eight times because you're a funded Searcher competing with private equity and going up Market it's a different story so I think in the unfunded Market the returns and the potential for high expected returns is just as good as

35:46 it ever was I think in the funded Market we need to worry about the multiples that are being paid how do we worry effectively about about you know a Searcher paying eight times ebit and out competing a private Equity Firm for whatever the reason that's something an investor is uncomfortable with they shouldn't invest in funded search that's a simple solution I just think they have a different model of of O of the way the transactions work

36:16 you know we have in sense this you know just like there's this division in investing between growth investing and value investing Royce and I have a very strong value tilt and we think you buy a business growth is great but you buy a business for three and a half four four and a half even five times and you're locking in a pretty good return even if you're not able to grow the business and so there are multiple ways to win really

36:47 essential in funded search it's different you're going up Market you're really betting on the growth hypothesis and you're trying to roll up you're trying to multiple Arbitrage you're doing a whole bunch of different things which have worked really great in recent past but who knows I mean I'm old enough to remember in having to study in graduate school when everybody thought conglomerates were just fabulous in the 1960s and then we woke up and said wow we don't really

37:18 need conglomerates anymore and the conglom and people went from the conglomerate premium to almost instantly to a conglomerate discount and that LED some of the acquisition waves which occurred so you think that I mean it sounds like it could potentially be kind of like two stories right there's there's the self-funded search story which stays at the lower end of the markets typically sub1 certainly sub5 million purchase price and then often

37:50 sub five often sub five or even sub five yeah and then funded search it's a little bit more kind of not anybody's guess but it's a little bit more of an unclear picture if they're doing bigger deals and paying larger multiples for those deals they just have to respect the expected return associated with paying eight times your you know eight times versus you know four to five times and they're really in the private Equity game either rolling things up driving

38:21 growth catching a cycle you know maybe getting lucky with a not lucky but you know having something great happen with like a strategic acquirer Etc it's just a little bit more of an open an open set of outcomes with with funded search than it is with with self-funded search I agree with that and I think it's also point out that the typical contract between the funded Searcher and their investors encourage them to to do all the kinds of things

38:49 you talked about it's not a steady Edie you you really need to do something with to F yeah you need to do something that's going to expand the risk to allow you to earn your return and your your reward so you as the Searcher so I think it all kind of makes sense right that that that you're paying a higher multiple is a riskier transaction both because of the risk of multiple compression and because the way

39:20 you've incentivized your CEOs encourages them to take that extra step to try to increase returns and you know when the returns happen it's great it's just when they don't that it's s yeah what do you guys think is going to happen to the MBA the MBA search has typically been a traditional search a funded search as Royce was saying earlier it was a search that was funded typically by you know like a kind of a cabal of you know of

39:52 of investors HBS grads guys like herb grck West big investor that some guys have you know but just there was kind of that whole category of investor and and so MBA investing was largely like a funded search not an SBA oriented search do you guys think that that could change so for us at HBS I would say if you asked our ETA class because we did

40:24 this recently right Royce and we said what are are your intentions with respect to funding I believe it was about 75 to 80% raised their hand and said they would do a self-funded search an unfunded search wow that's a big shift it's actually not a big shift at HBS it's been about that way for about a decade I'm surprised but you're corrected about most Business Schools it's right we Royce and I spend a lot of

40:54 time teaching about unfunded searches as well as funded searches we take a pretty balanced approach and in our investment lives we invest in both and we think this career path should appeal to people who are interested in both and they're different and the transactions are different as we've already discussed so we think we might give them a little more balanced treatment but when our students see that you can own six 60 70

41:28 80% of your business they get excited they get excited and so they're willing to go down Market in size pay the lower multiple but get the benefit of finding a terrific Target and when they find the terrific Target there's many investors who will take the 35 or 40% IRS even if it results in only 20% of ownership of the company I think in addition to the compelling

41:58 economics you know one consideration students think through is do I want to be the CEO of a bigger small firm or a smaller small firm what are my training and skills and inclinations fit better with it's not just a economic decision but as Rick said quite correctly economics are a huge part of the decision not all of it but huge why don't we Branch into talent and the way that Talent is evolving based upon particularly based upon some of what

42:27 we've been talking about and just the movement of more and more Talent potentially into the unfunded search category it sounds like it's I didn't realize it was as prevailing at at Harvard it certainly was not like that at Stanford maybe I'm just not following the data as carefully as as as you all are Peter I think you're exactly right Harvard I think is pretty unusual with in in in this in this way that that so many of our Searchers end

43:00 up going unfunded it may be because our students are a little older I don't know but it may be something I mean we've had funded Searchers they they always call Royce because he's a nicer one but we've had funded Searchers call Rey and take him to lunch and say investors investors investors right investors and funded search take him to lunch and say what's rubac saying why why why aren't we getting this great these these great funded Searchers right

43:30 why aren't we getting the talent why why is it going in a different direction I think we are different for that reason and so just going back to a comment from a handful of minutes ago as you said it used to be just kind of this male only field coming out of mbas it seems like you have the benefit of more and more self-funded oriented Searchers at Harvard that you've been able to teach you guys are also very excited about the

43:59 way that this career path could unfold for the multiple of people who will never go to a business school never go to Harvard Business School never go to any graduate school and so how do you guys do you field calls from people like that do you have conversations with mid-career Searchers we do and and in the fall it's really hard it's really hard in the fall because we have 200 students you know when I used to teach private Equity

44:29 Finance or Advanced Corporate Finance nobody you know we had some office hours but it would be like a you know little bit because nobody's changing their life because of your course and when we teach about small business a lot of students never really thought about it until they take our class and it's a transformative experience for some of them not all 200 but some of them and it opens their rise to choices that they hadn't imagined before and

44:59 they want to talk to somebody who knows something about it and thus they want to knock on one of our doors and so we do a lot of office hours in the fall in addition we have a group of visiting Executives who also who are former Searchers all of them and successfully Acquired and sold businesses and so we have them also meet with students so our students get a lot of time to talk to people but alumni do they they

45:30 reach out to us as well and we host alumni events periodically and get follow on questions so yes we do one of the things we're most excited about in our podcast is reaching out to in addition to people who have no connection to business school they're you know they've held some sort of executive job for a number of years they're interested in being an entrepreneur startups scare them you know startups feel feel frightfully risky or they don't have a big idea and

46:01 so it's it's presenting this opportunity because there are a lot of people who have no business school degree who have done this successfully and as Rick said at the start of the interview nothing succeeds like success and so when you can point as we do in our podcast to the journeys of people who you know maybe got a ba or eight or 10 or 15 years into their career and make a make a wonderful segue into owning their

46:29 own business it's I think it's we've seen before that it's it's very inspiring for people to consider it for themselves so that's an audience we really are trying to reach and I think can we go before we leave this Peter I I have a question what do you think that so suppose I graduated from engineering school and I've been working in various roles in an industrial company no p&l experience what is it that I need to

46:56 know about business to do a small business acquisition what do you think of that is Roy I think you have got to have learned sort of how to be effective with people in a business setting I think you so EQ stuff EQ stuff I I think you have some have to have some basic knowledge of like a p&l and you know how to read a financial statement you don't have to be a financial analyst but you have to be

47:21 able to be literate I think you just have to have some commercial you know that it's okay to negotiate you know you want to you want to make your cost less and you want to make your Revenue more but I think that's about it because you know these firms these firms that are being bought as Searcher Acquisitions generally aren't these really really complex things they're performing a basic Service as evidenced by the fact that the founder almost

47:50 never had an MBA you know the the founder was really good at that service or product but they were never trained as a manager almost always so it can be done I don't know Rick would you agree with that you asked the question I would agree so it's basic accounting a commercial sense I would say a little bit of risk tolerance and I would also say and maybe this is covered in your first thing but I would

48:20 add just the importance of sales that they have to be willing to go belly to belly with a potential customer and talk about the virtues of buying from their business instead of another business and I think if you have there may be another trade or two we missing but I think that's it I and I don't know you can ask whether an MBA actually helps in any of that it certainly helps with a financial

48:50 accounting and our students get to see hundreds of cases so they learn about business but that's not the only way to do it I would certainly say if you were that engineer that I was talking about and you were thinking about doing this a night school course on accounting wouldn't be a bad or an online course of some sort on accounting wouldn't be a bad idea I think that'd be a really good idea what do you think is the right

49:15 sourcing and searching model for a mid-career professional versus the traditional search in the traditional search World you raise Capital you put your head down and you go full fulltime building a pipeline of targets and opportunities right through all the various channels direct to owner through the intermediated channel you know you're running an allout campaign and that's your day job you wake up and you do that maybe you pull together a set of interns if you're 10 years in at danaher you know

49:44 10 years in at trans diim you know one of these fabulous industrial businesses or not you know you know or or something you know that's kind of like less well known but how do you start the search process as you said earlier it's a huge family decision so you know you're not just going to like pause your job and resign probably and and and start searching full-time unless you're you know unless you are that's what I'm

50:16 asking you guys like how how's this happening if you're a mid-career guy like what is the process by which you create the room to go at this you're asking a great question and it won't surprise you because it's a great question we get asked this question a lot by people who are considering this I'll offer a couple of thoughts I know my partner has a couple of thoughts on this too you know if if you're a

50:37 mid-career Searcher and you're going to do a self-funded search and therefore you're buying a smaller small company imagine sort of a million dollars nebida as somewhere in the midpoint of what you might be buying a little smaller a little bigger what I think we would do is we would start contacting small business brokers of whom there are something like 3,000 in the United States and seeing their listings because you're then dealing with sellers who have made some

51:04 kind of commitment to sell their data has been somewhat organized by the broker there's a process and you're at an end of the market where there isn't that much competition it's not zero competition but the competition isn't Fierce and you are you are letting the broker be of real assistance to you in presenting you know qualified opportunities you can later Branch off and add a direct sourcing wing of cold calling owners that's very labor intensive but

51:33 maybe you'll find a segment or two that fascinates you through that search and you'll add that on but for this kind of searching I would a use Brokers and B sadly tragically I hate to say these words but I would make it a full-time activity because you need to look at a lot of deals to find that very good company to buy and and that means you need a lot of at bats and it's hard to

51:58 do that when you're working 9 to5 on weekdays but but I'd like to ask you Rick what do you think well I think some people get lucky and some people search part-time and they find the deal of their dreams and they're able to move it forward and and and they become famous in the search world we've done a podcast or two with with people who have done that and and that's just wonderful when it happens but I I don't think I don't

52:27 think you should depend on that I think for most people you really really have to work very hard to find an acquisition Target that you are interested in that's available that you can buy and so I I think it has to be a full-time job and I think more importantly you know and your in the scenario you described Peter I think what you need to do is in

52:58 addition to do it full-time you have to shut off a little bit of the family noise you have to because just like that that typical parent who wed about whether their their child was actually working when they were hanging out in their pajamas all day long staring at their computer so too will this person's spouse and so you need to turn off some of the noise just because you're searching full time doesn't mean you can take the cars in for service because

53:31 you don't have anything else to do all day long that's actually not the case and a as for sourcing the one thing I would add to Royce's comment I love broker sourcing but the other thing that's really important is that more and more people are doing Geographic searches and if you are doing a geographic search Brokers are inefficient or difficult way to do that because Brokers are quot many Brokers most Brokers take mandates in a

54:03 pretty broad region or even nationally and so you can't if you want to buy a business in Boston you just can't look in Boston based Brokers you won't find it that way so we really strongly recommend that if you're doing a g Geographic search you embed yourself in the business community in the place you want to buy so so that means you want to go to the Chamber of Commerce breakfast you want to go to the Rotary Club you

54:32 wantan to you want to meet with attorneys you want to meet with a state attorneys I I I think it would be great if you could meet with cardiologists but they don't they don't really like that idea but you know find out who the potential sellers are going to be somehow you know be active in whatever religious organization you can be true to be active in it because you need to embed yourself the business Community however you do it religious

55:00 organizations softball leagues whatever it is if you were to sort of like sketch out a version of the future 5 to 10 years from now and the self-funded sort of ETA category had how would you like to see it in its more sort of fully mature State like what what is the picture in your mind of what you're hoping to see where ETA is gone completely beyond the circles of of the top MBA programs it's now this very

55:33 significant you know separate category of mid-career professionals like what how could you paint a picture sort of what that looks like in a maybe more stable State I'll put one you know paint stripe on the picture and and and Rick then I'm going to turn it over to you to to add to it but I think one characteristic of ETA in the future that is very realistic is that it will be extremely common that people 5 to 15

56:01 years in their career as they think about alternatives to the job they have that they may not be completely satisfied with or thinking about buying their own small business in exactly the same way today as they think about you know switching jobs that other advertising agency or Distribution Company or whatever would be the obvious company to company transitions in their industry they're also thinking on that list or should I just is this the moment for me to buy by my own company which is

56:27 not where we are today but I think is a reasonable expectation of just a widespread consideration of that as an alternative Rick how about you what would your vision of the future be I love that what I would add to that though is it would be great if somehow the transaction process particularly on the low end of the market got a little streamlined so it would be really terrific if there

56:58 became the kind of standardization in data rooms you know when you buy a house you get kind of a reasonable amount of uniform information you know the age of the house you know how many bathrooms it has if you can you know if you ask they'll tell you when the last roof was put on they'll tell you what kind of heat it has right you're going to get some welldefined data about a house just through an

57:24 MLS listing and while I don't think we're going to get MLS list people are trying but I don't think we're going to get MLS listings because owners tend to be very secretive for good economic reasons but it would be really nice if some of the things which has happen which have happened in slightly larger transactions for example there's a qov by a reputable firm done by the seller maybe we don't go to that stage but we

57:51 go to something where we've where we've streamlined made the data analysis much much easier so that people that don't have you know you don't have to be an architect or an engineer or a builder to buy a house and feel confident about the house that you're buying we would like I would love it to be the same for a small business and do you think that like I mean the the rush of capital or not rush

58:19 but like the the the growth and the prevalence of equity and you know Equity Capital as well as like the national lender I mean is there an Evol like could there be a set of fit for-purpose changes in terms of equity and debt facilities for the mid-career self-funded Searcher it feels like a lot of the institutional debt and Equity providers not all of them but it seems like a lot of them are sort of looking to create tradition you know they're

58:45 backing a lot of traditional Searchers at least on the equity side do you think that Evolutions to the to the equity and the debt facilities that like could get built to to specific speically back the self-funded Searcher I know there's a 20% limit otherwise you have to sign up to the personal guarantee like you can't own more than 20% as an equity owner otherwise you have to be a co-signer on the personal guarantee but I'm just curious

59:11 whether there's like structural changes to the the equity and debt Capital markets that could help bring this about in addition to the streamlining ideas that you've both mentioned well I think on the self-funded side you know we're we're seeing a rapid streamlining of equity to self funded Searchers and that is that today there are now professional funders of self-funded Searchers in the equity piece and if you go to one or two of them and they like

59:36 your deal they'll introduce you to eight or 10 other recurring investors in self-funded search equity and you will rapidly get your Equity table filled out even if you personally have no network of investors and that is a gigantic change and a gigantic easing on the debt side you Peter you make a great point I mean I think it's hard for conventional loans to compete with SBA Loans but when you get above the $5 million loan side

60:05 size there for the self-funded Searcher it becomes more challenging getting term debt and so somehow either getting more institutions that are interested in lending to self-funded Searchers and maybe the five to eight million dollar loan range would help somewhat you want to just Rick I want to make sure we cover the Talent changes that you mentioned earlier a little bit we've only touched a little bit on it just in terms of both the skills that people

60:35 have as well as it going from being you know like a sort of male-dominated NBA field to something much bigger and broader than that how do you see you know how do you see it getting more diverse in terms of the talent that's in it do you think of you know like what do you think could be a stable state of female search entrepreneurship versus male entrepreneurship do you see diversifying more across like degrees like engineering and and you know and

61:01 you know liberal arts as opposed to you know other vectors like what are what are the ways that it gets more diverse you know over the next five to 10 years that's such a big set of questions and and I'm not sure I'm the best person to answer those but what I would say is just repeat what I said earlier nothing succeeds like success so when we have searchers in our classroom who talk about what it was like to have babies

61:29 while searching what it was like to be raising a family while they're running a company I think that opens the eyes for a lot of women a lot of women say wow if I want to succeed in my typical private Equity job and of course there's wide ranges of differences across firms but I have to be willing to commit to lots of hours particularly when I'm in the middle of a deal and I

62:01 really have to put that deal front and center whereas if I run my own small firm I can set my own schedule I can set my own agenda if I need extra help I can get another assistant in the office I I I have control I can't control my customers of course I can't control financial markets I can't control the national economy I'm not saying there are no risks in the world but I can control what happens in my own

62:27 firm I can control the team I work with and so I think what we're seeing is that many women are looking at the ETA career path and saying wow that really is compatible with having a family that is compatible with having dinner with my with my partner and my children every night I I could do that I might end up working on midnight every night after I put the kids to bed but but such

62:58 as life there are no jobs that pay a lot of money that you only have to work 30 hours a week on I I think that they're just not a whole lot of those I don't know anybody who's successful that doesn't work 80 hours a week so I think people are seeing those role models and those role models are being successful and so that will further expand and I think that's true just across the Spectrum nobody chooses to do business with a

63:24 firm because of the race the gender the age of the owner the religion of the owner that's not why they choose I mean maybe some do but most say what I really care about is I'm getting a great service I'm getting a great product and I'm getting it at a good price and it's helping me do whatever I do better it's been great to zoom out with you both and just you know dream about sort of where

63:52 this Market can go over the next 5 to 10 years years with the benefit of all all the exposure that you guys have Can is there an update to your book or are there any forthcoming Publications that that the audience can look forward to from either of you or well we have a terrific podcast that that that collects a lot of our ideas and you know we've talked about whether we would update the book or not Roy's the

64:24 listeners won't know this but Royce is smiling with a big chesher cat kind is that the right word Royce cat kind of smile because we've been for two years discussing whether we should revise the book or do the podcast we've done the podcast we love it the new Season's coming out this winter and there'll be another season think big by small you should say the name think big by small the same name as our book is

64:53 coming out and it's been pretty successful but it as you know probably Peter it it is not it while it might be an effort of Love it does take some time so that has pushed the book project off a little bit well it's great meeting you guys it's great to be with you I really enjoyed the conversation and I'm excited to be a listener to the podcast and thank you for all that you've done to put your work out

65:24 into the world through the book especially which obviously goes so much further than the HBS classroom that's obviously an incredible way for the world to learn about what you guys have been teaching up in in Cambridge so thanks for coming on to the podcast and spending this time with me I've really enjoyed getting to meet you all and talk about these topics that we all care about so much thanks for having us it's been a pleasure speaking with

65:46 you yeah it's been a real Delight Peter thank you Peter lman is the CEO of axial all opinions expressed by computer 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 axal