Host: Welcome to Acquiring Minds, a podcast about buying businesses. My name is Will Smith. Acquiring an existing business is an awesome opportunity for many entrepreneurs. And on this podcast I talk to the people who do it. Mark Sinatra acquired an HR outsourcing company as the target of a traditional search fund. Over the next decade, he tripled the size of that company, then sold the business to a private equity firm. And then for the last couple years, Mark has been investing in search funds himself. That first acquisition was back in 2008. So this is someone who not only was successful as a searcher, but has been in and around search funds for 13 or 14 years. There's been a lot of evolution in the search fund world in that time, not least of which in the popularity of the model.

Guest: So.

Host: So Mark's perspective on traditional search funds is a great one to get. Enjoy my conversation with Mark Sinatra. Mark Sinatra, thanks for joining me today on Acquiring Minds.

Guest: Will Smith, thank you for having me.

Host: You acquired an HR outsourcing firm back in 2008. It was the target of a traditional search fund. So you had done a search fund right out of grad school, out of an MBA program. And this was at a time when search funds weren't as widely known as they are today. So you did a search fund, then you acquired a business, ran and grew that business, exited it, and now you are investing in other searchers. So you really have seen the entire life cycle from being a searcher to a successful acquisition and exit to now investing in searchers. So lots to hear from you, Mark. But before we dive in, why don't you set the stage for us? Give us two minutes on you pre 2007, 2008, what was it that led you to want to do a traditional search fund? Search fund and go out and buy business?

Guest: Yeah, absolutely. Well, thank you. Well, and then just one, one minor add to the background. So I actually got back into the HR outsourcing space recently and I've been running another HR outsourcing firm called Aspen hr. So I'm doing that and then I'm also doing some investing as well in search funds back in 2007, 2008. I think for me, for a lot of folks that attend MBA programs, it's a period of deep learning and reflection and you're trying new things, you're learning about new things, and all the while you're trying to think of, well, what's my path, what am I getting to do long term and what can I do short term to help me get to that long term goal? And you know, when I first heard about the search fund concept the summer after my first year of business school, it really kind of instantly clicked in my mind that it was essentially what I was looking for, but I just had no idea it was called a search fund. I had no idea that there was a path. Right. And a path that was created. Right, right. By several other search fund entrepreneurs prior to me that had successes, that had challenges. But all the while, we're able to really create this path of entrepreneurship through acquisition. And so my thought process back then was the search fund model was really the perfect fit for my career goals. I knew I wanted to eventually run a company, and I saw the search fund model as the most direct path for me to do that, with the exception, of course, of starting a company. But starting a company for me and what I knew about my skillset and my skill gaps and my risk tolerance, I didn't feel like starting a company was really the right option for me at that time, and that the search fund model really checked all the boxes in terms of my goals, my and my risk tolerance. So great.

[4:14] Host: And what was it about building that that you thought, like, didn't appeal? Was it that you just didn't have an idea right at the moment or you just starting from absolute scratch was you were more of a, you know, as they say, like a one to ten person rather than a zero to one sort of thing?

Guest: Yeah, I've thought like, well, first I didn't have an idea that I was just uber passionate about that. I thought that, okay, well I need to start a company around this idea and execute it. And then in conjunction with that, frankly, I just didn't have the financial risk tolerance at that time to really kind of devote and kind of go all in on the startup concept. And so of course there's risk associated with the traditional search fund path, but I felt like part of that risk was mitigated in the sense that you're searching for up to two years and at least you are paying yourself a salary. Now it's a below market salary, but at least it's certainly something that you can more than live off of. So I really kind of felt much more comfortable with that model.

Host: Okay, so tell us about the search. What did, what did that look like? Did you have a lot of interns working with you? Did you, you didn't have a partner. As I understand it, you were solo. So tell me, tell me what that looks like.

Guest: No, actually, so ended up, I did have a partner for, for the search and even for A portion of the operating period as well. And I was actually, yeah, it was actually a classmate and friend of mine from, from business school. And so I conducted the search out of New York and my partner, he was actually out of, out of Minneapolis. And so it was actually kind of a nice setup where even though we weren't searching together in person per se, I think we had a good complimentary geographic coverage there. In addition, we had some interns as well. Now, this was kind of, this was like, I would say, in the early days of interns. Right. And so there were a lot of. We were learning as we went, honestly, in terms of how we would kind of best structure the internship and who was the ideal intern. Right. If it was a MBA student or an undergrad or none of the above. Right. So I think they were helpful to us to some degree in terms of like, reviewing industries and, and, you know, putting together lists. But nowadays, not to jump to, to, you know, future question. Nowadays, you know, I find that the interns and internship programs are much more structured and robust.

[7:03] Host: Yeah. Well, and just in terms of the search itself, the interns and otherwise did like, had you taken a course, like, was there even a course offered in search at your MBA program? You were at, you were at Wharton, right? University of Pennsylvania.

Guest: Yeah. Yeah. There's a course called Entrepreneurship through Acquisition that really focused on, I would say like business acquisition 101, you know, for typically, I would say smaller companies, you know, companies sub 5 million in revenue, sub 1 million in EBITDA. And I think some of the lessons from that course were, were certainly helpful. But I think the, I mean, there wasn't a lot of content that was specifically tailored to the traditional search fund model. And when you're doing a traditional search, right. Like the companies you're looking at most searchers, the floor is really one and a half in EBITDA and could be up to five, maybe even higher. Right. So the competition for those deals is far greater. And so that's one key difference is like that we just kind of picked up as we went. Right. You just have to be much more kind of crafty and creative in terms of sourcing those types of deals. So there's the Stanford Primer at that time that was certainly helpful. And then it's always been a collegial community. So I found like the searchers I was able to kind of find online and talk to about what the lessons learned about their search were actually very helpful. To your point back then, it's not like there were a ton of Searchers that you could easily find and leverage. So it was really a lot of learning as we went.

Host: Yeah. And there wasn't as much of a playbook, I don't think. Although maybe in the Stanford primary there is. But as I've started talking to traditional searchers now, I realize more and more that they're traditional searchers of today. There really is a formula almost to follow. I mean, it doesn't mean you're going to be successful. As you said, it's still very competitive, very hard to find those companies that fit the bill. But there's a process and step by step kind of way to do it.

[9:27] Guest: Yeah, I mean, I think, listen, I think it's great that exists and because that's really one of the biggest challenges of the search is you're putting forth all of this effort into a binary outcome. You buy a business or you don't buy a business and it's like if you're putting forth all this effort and you're working tirelessly to do it and you're 18 months in and you still haven't achieved that outcome, like how do you know if you're being successful or not? And so there's a lot of latency built in in terms of, you know, you get that loi signed one day, right. And then you're moving. Right. And then you go to the purchasing room. But if it's just, it's. That is the biggest challenge of the process is really to kind of keep yourself mentally kind of engaged and kind of optimistic, you know, into, into, you know, achieving the ultimate goal.

Host: Yeah, yeah. So how long did it take you guys to find staff? One.

Guest: It was 18 months. Yeah. From beginning.

Host: So you were speaking from experience on the 18 months thing?

Guest: Oh, yeah, yeah. I mean, for sure. I mean it, you know, from beginning to end, 18 months. Found the deal about 13 months in and then, you know, basically like a five month period. Right. To, to ultimately transact, you know, found a business through essentially kind of a industry consultant, river guide, you know, great person, great resource, who was really, I think, like, well, networked within the sector, you know, and the industry appealed to us. Right. I mean the, the HR outsourcing industry back then and even through today has a lot of similarities. That's changed in some ways, but a lot of similarities in terms of recurring revenue fragmentation, industry growth, nice industry tailwind. So I think what we saw in it back then again, I think to a good degree still exists today. And so it was a bit of an industry focused search is how we were able to come up with the deal.

Host: So can you tell me more about the outsource HR outsourcing as an industry and what appealed to you about it and how it's changed? And is it something that you still recommend for searchers?

Guest: Yeah, yeah, I mean absolutely. I mean the short answer is, I mean I absolutely recommend the industry for searchers to really sift through because it's got some fantastic attributes. Like I said, I think the recurring revenue nature of it, the scalability of the model, the fragmentation, allows for both organic and potentially inorganic growth as well. If we look at everything that's going on in today's labor market, with increasing proliferation of HR laws, regulations, you've got state and local mandates as well. They're very unique. And you couple that with the increasing geographic dispersion of the workforce, remote hybrid work, employees moving to other states. Those confluence of factors really create in my mind really an HR nightmare for companies that have 20 employees that just are not prepared right to really meet those demands. And so that was really what got me to really fall in love with the industry is I kind of looked at it as okay, well if I buy a plumbing company, if I buy an H VAC company or whatever it is, it would be a no brainer from my perspective to use one of these HR outsourcing firms because it would give me the peace of mind that we would be compliant with all applicable laws, regulations and give our employees access to high quality benefits. I just fell in love with the value proposition and I really believed in it. And that's really one of the most important boxes to check because as a searcher it's unique. You're not just buying the business, you're going to run it. For me, I really had to have that staunch believe in the value delivered in this industry by this company. And it really checked that box for me.

[14:04] Host: And what about, I mean you yourself exited staff one to a larger company which then a year or so later exited to an even larger company, Paychex, which is almost a household name in HR outsourcing. So how fragmented does the industry remain or are there just these really big guys? And compare it today to when you started in 2008.

Guest: It's a great question because you're right, there has been a wave of consolidation in the industry. If I think back in the last couple years, there's been several new private equity backed platforms that are being acquisitive. And so at the same time it's an industry that is a couple interesting dynamics to it. I would say the barriers to entry are moderate, they're not low per se, or they're not extremely high. But I would say they're at a moderate level. That still for somebody that's got the access to capital and the know how and the network and the grit, you know, they can certainly start right in HR outsourcing peo firm. But one kind of factor that I, that I want to call out here is that the barriers to scale, right, the barriers to thrive I think are actually very high. Because what I've seen is there's a lot of firms and it's not just emblematic of this industry. I've seen this in other fragmented industries where to scale above 1 million ED, but 5 million revenue, it requires another level of investment or perhaps a different skill set that results in these firms essentially kind of plateauing. Right, okay. And there's nothing wrong, I mean it's nothing wrong with that because it can be a great, you know, they can build a great company, it can be great lifestyle. Right. For that owner. But as a result, you know, it's, it's just hard for them to kind of like get over that hump and get to the 3 to 4, the 5 million EBITDA, you know, level. And so, yeah, so that's a dynamic that I've noticed in this HR outsourcing industry is that there are new ones that are starting. I mean, I just read about one today. I mean there's new ones starting every month. Right. But ultimately there's, I think a good portion of those will grow, but they may plateau at some point, which further then kind of leads to the fragmentation that we see in the sector. And then they in turn could be good targets for larger acquirers down the road.

[17:06] Host: So tell us about staff one and what its numbers look like when you acquired it. And you know, was it below that hump that you're talking about? And then did you get it beyond the hump of the 1 million EBITDA or 5 million in revenue? Can you share? What can you.

Guest: There's only some. Yeah, thank you. I mean there's only, of course, as you know, so much I can, I can share, but I think like from a top line perspective, you know, I would say at our, at our low point in the, in the early days, we, we were doing right around, I would say like just right around 18 or so in net revenue. And then when we got time to really look for potential suitors to buy the business, we were just south of 50 million in revenue, so had a good Nice run of growth. Say about 80 to 85% of that was organic growth and about 15 to 20% was a result of inorganic growth. A couple small tuck ins that we did towards the end.

[18:11] Host: So 18 million to 50 million over the course of about nine years. You acquired it in 2008 and exited it at the end of 2017.

Guest: That's correct. Let me say this. It was not, certainly not a linear path to that. You know, there's a lot of, you know, a lot of ups and downs and you know, particularly you know, in the, in the first, in the, in the early innings, so to speak.

Host: But can we dive into that a little bit? What were those first couple of years like? Cause you had mentioned that to me offline, that your first couple of years in this seat were difficult.

Guest: Yeah, I mean, listen, I mean it's always, I mean I think there's always challenges, right, at like any point, whether you're, you're starting, you're scaling, you're established. I mean it's, I think there's just like different challenges, right, that present your, that are presented along the way. I think in my, my case, listen, like the company that, that we bought and it was a great company, you know, I think like trying to really convert it and, and you know, kind of invented into a growth platform required I would say like a, you know, some, some, you know, fairly extensive changes to the business. You know, from a, from a technology perspective, you know, from a, from a sales perspective, you know, people perspective. And, and so, you know, one of the, one of the, I think the big lessons I learned is I think in the early days I was a little too quick on the trigger to execute on some changes and perhaps could have more intentionally thought about what changes to make and when or maybe what changes not to make. Because I think what, what's easy to forget sometimes is some of these smaller companies are. There's a certain level of fragility to them. Right. If you've got a company that has 25 employees, 10 employees, even 50 employees, there's just only so much those companies can really handle adequately at once. And, and that's one of the big takeaways I learned was just to be more thoughtful about the extent, the frequency of different initiatives and changes that I wanted to make.

Host: So you came in there really eager with your list of things to do and you started knocking off the list and you just quickly bumped up against friction and disorganization.

[21:04] Guest: No, I mean, I would say I don't know about friction per se, but it was really just the. It takes a long time, right, to execute and to execute projects and initiatives. And that's on top of running and growing the day to day business.

Host: And

Guest: I think the capacity for a lower middle market company to absorb, you know, changes and to actually, you know, execute on, on, you know, initiatives is, it's not a, you know, it's not an infinite capacity. Right. So you have to be very, very strategic and disciplined about where you spend your resources. And that's really defined as, you know, dollars, time and your staff. And if you can kind of figure out whatever that optimal formula is, then you're onto something. But my point is if you kind of overburden your resources with too many initiatives at once, there's going to be a disequilibrium there that is going to result from that.

Host: Yeah. And in terms of the, I mean, this fragility, the question of this fragility and the risk of buying a small business, what did you see as the kind of, what were you concerned going into the acquisition of staff? One would be the biggest fragility, the biggest risk really to you. And then after you acquired the business, did that turn out to in fact be the riskiest aspect of your ownership? And if not, what was it? What were the immediate challenges that you saw that maybe you didn't see before you got in there?

Guest: Yeah, I mean, a couple things come to mind. So one of them is the timing of the acquisition was candidly not ideal in that it occurred essentially in the early days of the middle of a recession. And with having a client base of small and medium sized companies with an average client or employee count of 22 employees, the concern was, well, how long will this recession last and how severely impacted will the client base be? The interesting thing is we didn't have, I wouldn't say we had a material amount or percentage of clients that went out of business. We had a lot that were basically leveraging the recession to save some dollars and to renegotiate rates and pricing with us. And so that was really the bigger challenge for us was that margin erosion that we saw. And it was kind of a case of, you know, a bird in the hand, so to speak, where, you know, do you really want to lose a client? Where they could, you know, perhaps go to just a payroll company and save some dollars or do you want to keep this client? And you know, we frequently chose the latter. Right. And just kind of take that in on the margin and try to keep that client for, you know, as long as we could you know, the other risk, it was on the technology side and we had a. It wasn't our own technology, but we had a license to a technology platform that we provided to our clients, you know, payroll and HR technology platform. You know, the thought was that, okay, we really need to upgrade this platform, right, to provide our clients with just a higher level experience and for us to operate more efficiently internally. And, you know, certainly on paper it was the right decision and I think it really, I think worked out well for us and for our clients. However, the extent of that, like that project and the migration was it. It definitely like, took longer to execute than I had anticipated. And the interesting thing is, even though the vast majority of clients saw this as a positive change, there were still some that despite the improvements, they appreciated the old platform because it was a process and it was something that they were comfortable with. Right. And so what that said to me was sometimes even if there's a change that we think is going to add value and be positive, you know, not every single client is going to have that same view. Right. So, you know, just be prepared for, you know, perhaps some attrition challenges, even if you're going to make, you know, sometimes what you deem to be, you know, a positive change. But I mean, just off the top of my head, I mean, like, those two were definitely the, you know, the bigger challenges, you know, that we dealt with, among others.

[26:26] Host: Let's pivot a little bit now. Mark to your perch as an investor today. So I assume you're talking to searchers and kind of getting a window into a lot of these search processes. Is there anything that you would tell people that you see come up commonly that maybe they're approaching in the wrong way or could be doing better? Any generalized advice for people who are considering buying a company out there?

Guest: Sure. Just in terms of the search process.

Host: Anything you got, but sure, we can start with search process.

Guest: Yeah, yeah, I mean, listen, I will say this. I've been actually very impressed with what I've seen from searchers today in terms of, you know, kind of what you alluded to in the beginning. You know, the playbook, you know, it's, it's, it's definitely more, more structured today in terms of how you utilize your interns, how you source deals, how you scrape lists. I mean, obviously technology tools available today are far more effective than, you know, when I think, when I was searching. So I've actually been super impressed with the ability of searchers to really effectively source source deals. I think the lesson to really Impart is that, and this is really one of the biggest advantages of being a search funder is that at the end of the day you're buying a business from another human being. And chances are that seller has never sold a business before. And so it's so, so critical to establish that strong relationship and rapport and trust up front with that seller. So despite all of the deal sourcing machines and the technology tools and all that and zoom and all the stuff that exists today, which has been fantastic from an efficiency perspective, at the end of the day, the most critical thing in the early days of a transaction, like I said, is really to establish that trust and that relationship with that seller. I think the searchers that have proceeded to, I think, acquire companies and do well and have been able to kind of keep that lesson in mind as they come across deals and sellers.

[29:10] Host: And so do you encounter searchers, the ones who don't do this well, a lot, who maybe just treat it very transactionally or don't take the time to build rapport? I mean, is this a common misstep among searchers?

Guest: I think it evolves. I think that skill set evolves like during the search. And so perhaps at the beginning of the search there's really a natural drive or rush to get deal flow. Yeah, and, and to get at bats and to see what you like, see what you don't like. Which reminds me, that's another lesson I want to make sure I mentioned at the end of this. But I feel like the searcher over time through those at bats, gets to appreciate the human element of the acquisition process and as a result learns that, hey, one of the ways I'm going to set myself apart here is the fact that I'm not just buying the business, but I'm the succession plan for the seller and really, really hones in on that, that factor. You know, the other lesson real quick is, is, and this is a hard one to avoid, admittedly. And the mistake you know, I most certainly made is that it's really easy to spend too much time on a deal that you're really never going to do. And again, like, that's, it's easy for us, right, to like sit around a table and say, yeah, it's this mistake, you know, that everybody makes. But it's one of those things that like, you kind of have to like, you know, you realize it certainly after you do it once, you know, you realize it, you know, and I think like searchers have done a better job of just running deals, you know, by their Investors a little earlier in the process just to kind of vet out interest, see if they're missing anything. But like I said, it's a really easy mistake to make particularly in the early days. Right. Of search and mark.

[31:26] Host: What do you mean? Like what do you mean? I'm interested, I'm looking at this deal, I'm investing time. But I should know that I'm not actually going to do it. Why should I know that?

Guest: What I really mean is so if there's a deal, say it looks, I mean it's maybe a hot industry and company's growing, maybe the valuation perhaps could be on the higher side of things. But it's a really exciting deal and so there's a natural kind of curiosity and really interest to delve in further put out indication interest, maybe even put out an loi. But what I'm saying is if a deal like that isn't really properly soft circled with some investors then unfortunately there could be a situation where the deal gets under LOI and there's more time spent. But ultimately there's a challenge just ultimately raising whether it's a debt or the equity. So that's really my point is just ensuring that there's at least some minimal, some level of support right. From the capital sources before you really, really kind of dive in and get under exclusivity and certainly before you start engaging any third party advisors.

Host: Okay, so take a deal to your investors sooner than maybe sooner than later. There's a sweet spot like where you've over invested time and then of course there's also too early. But it sounds like you see searchers err on the side of doing it a little too late. You'd like to see them do it earlier because you've seen instances where investors are like look, I just, for whatever reason this isn't for me, I can't fund this.

[33:19] Guest: That's right. That's right.

Host: And speaking of investors saying no thank you, are there any criteria that you can lay out for what you look for in a deal or in a searcher or things that would be deal breakers? Anything there. Searchers are always like to see inside the minds of investors. So anything there you might want to share?

Guest: Yeah, I mean on the deals, you know, I think, I think we always look at things such as, you know, revenue consistency, you know, if there's too much customer concentration, you know, basically any, any like areas of significant risk. Right. That cannot be properly planned for or mitigated. You know, the people, the quality of the team. Right. That's Sometimes like a tough one to ascertain, but you know, the roles of the sellers, you know, afterwards, how important is the seller to the business? And then, you know, looking at, you know, the industry dynamics, you know, are there tailwinds or are there headwinds? And, and really getting a good grasp of that, I think, and a good segue to the searcher, trying to ascertain and assess the fit between the company and the searcher and the level of conviction that the searcher has about the transaction, you know, the quality of the relationship that the searcher has been able to build with the seller throughout the whole process. Just off the top, man. I mean those are, those are really important factors, you know, to vet. And then, you know, lastly, I would say really understanding the assumptions that drive the base case in the model, you know, what are those like kind of bottoms up assumptions that are going to drive revenue? And you know, how, how does that kind of line up with historical performance? You know, really just getting the best understanding you can about the, the kind of the, the ability and the probability of execution, executing to the, to the base case.

Host: When you were taking your staff one deal around to investors in 2008, I don't think you had any HR experience. What was it that you used to convince your investors that there was good searcher business fit, searcher acquisition fit there? Was it just your conviction, like you laid out for me earlier, your conviction in HR outsourcing and how enthusiastic you had become about that opportunity in industry?

[36:20] Guest: I mean, that's a great question. I mean, I think the conviction helped. I mean, I think the senior team at the time had been in place for that really strong tenure at the business. And so the thought was to really kind of leverage that senior team to help grow the business, you know, the business. It's interesting, like theoretically it's a very simple business, right? I mean you're basically processing payroll, you're providing, you know, HR compliance support, you're providing, you know, employee benefits, administration. Now I would say operationally it can be actually a fairly complex business, right? And so I think like for, for folks coming into this space as a generalist, right, like without really having any background, you know, the natural, like it was natural to kind of navigate towards things like strategy, sales, marketing, you know, things like that that could really help drive the business and then, you know, learn the best you can, the nuts and bolts of the operation, but really kind of leverage the management team to continue to manage and execute on the day to day aspects of the operation.

Host: Mark, for anybody out there looking to pursue an acquisition via search fund. How can they get in touch with you if they have questions or maybe want to bring you in on a deal? Is that something that you're open to people reaching out to you about?

Guest: Yeah. Yeah, absolutely. So my business partner, his name is Matt Zucker. And so we both have an entity that we invest in search funds. So you can reach out to any one of us. So Matt's email is mataequity.com and you can also reach out to me as well@markettaequity.com and your website, is there a

Host: website@etaequity.com that people can brush up on before they reach out?

Guest: Yes. Yes. Great.

Host: Great. Cool. Etaequity.com everybody. Mark, this has been great. Thank you very much for sharing your insights as an investor and a successful searcher.

Guest: Thanks. Will appreciate it.