What Searchers Can Learn from Big PE

lex Mears brings expertise from the world of big private equity to our world of buying small businesses.

Alex has worked at both Carlyle and Blackstone, two of the marquee names in private equity, and along the way has invested in upwards of 70 searchers on the side, 40 of whom have actually completed their searches and bought businesses.

He recently launched The Brydon Group, a search accelerator, alongside partners Steve Ressler (a high-profile search investor) and George Dutile.

The Brydon Group is accepting applications for its first cohort, with a deadline of June 15th. You can apply here.

Following are 3 highlights of my conversation with Alex.

The Most Valuable Businesses of All

A big part of the skill of private equity is identifying high-quality businesses, and one of Alex's favorite characteristics is the combination of high criticality with low materiality.

Said more simply: crucial, but low cost.

You want a business whose product or service is crucial to its customers. Obvious enough.

But ideally, your product or service is also a relatively small expense — immaterial — for them.

If it's a high expense, your customers will be forever squeezing you on price.

If it's low, however, it flies under the radar. Your product represents such a small line item that it's not worth their time to negotiate price with you.

Alex provides 2 examples.

A major auto components supplier to a car manufacturer is critical to that manufacturer. However, the component parts represent a high cost to the car manufacturer, who will push and push the supplier to lower prices.

By contrast, Alex once looked at a business that made tiny, customized rubber plugs engineered to perfectly fit a certain engine.

The price of the piece was about $1 — a rounding error on the thousands of dollars in other costs that went into manufacturing the engine.

A critical piece, of low materiality. Perfect.

"Your customer could look for cost cutting every day for 10 years, and they are never going to get down to the line item of arguing over whether your dollar plug should cost a dollar or two dollars," recounts Alex.

He points to SaaS businesses as another good example.

Often a SaaS solution provides critical functionality to its customers, but at a cost that is very low relative to its customers' other expenses.

Nonnegotiable: Seller Integrity

Acquiring Minds guests report over and over how important trusting their seller was to a successful transaction and transition.

Alex is no different, going so far as to say that any whiff of dishonesty is a deal breaker.

It's not only that you need to trust that the value of the assets you're acquiring are true to your price.

It's also the fact that dishonesty in a business owner tends to ripple throughout the organization, so you will likely find obfuscation and misdirection at all levels of your newly-acquired business, and maybe even in outside dealings with customers and vendors.

"The math is such in search that, as long as you buy a good business and are able to do well, it will handle itself. That is a great outcome," says Alex.

Alex makes 2 additional points here.

First, there are thousands of good businesses to buy, with above-board sellers. Just find one of those. Why lower your standards to dealing with anything else?

Second, the low valuation of small businesses (2-5x) is so low that as long as you don't screw it up, it will almost certainly be a great investment. So why burden your acquisition with the additional risk of a dishonest seller when you can find an honest seller at what is still going to be a great price?

"The math is such in search that, as long as you buy a good business and are able to do well, it will handle itself. That is a great outcome," says Alex.

When to Speak to Key Employees

One of the biggest risks in search is the team you're inheriting.

Is there key-man risk?

Are the employees happy?

Will they immediately demand raises when you step in as new owner?

There are many important aspects to evaluate when it comes to the team — a subject for another day.

The takeaway from Alex is when, during the transaction negotiation, to require speaking to the team.

Most sellers, including honest ones, are going to resist letting you talk to the team.

They don't want to create anxiety and disruption among their employees before the deal is done.

But as the buyer, you want to speak with key team members as early as possible given what a valuable source of information & due diligence they represent.

So what is the sweet spot — not too late in the negotiation for your comfort, not too early for the seller's?

Just before signing the final agreement, says Alex.

"There is often that period where you've effectively agreed on all the terms at that point. And then you basically say, 'Hey, before I sign this agreement, I need to meet X, Y, and Z. And I need to do so in an unchaperoned manner.'"

And make sure you tell your seller well in advance that this will be your expectation. (To that point, early transparency about your entire transaction process is recommended. Set your seller's expectations.)

Watch the full interview:

Sponsors

August Felker is a 2-time successful searcher — first with a traditional search fund; the second time around, he did a self-funded search.

Today August runs Oberle Risk Strategies, an insurance firm with a dedicated practice group for searchers and acquisition entrepreneurs like you.

If you've got a business under LOI, Oberle will provide complimentary due diligence on that business's insurance and benefits program. A great, no-risk way to get to know August & team.

They love helping searchers; they've worked with hundreds. Oberle is a specialty insurance brokerage for searchers, by a former searcher.

Check out the Search Fund Team at Oberle.