Tim Ludwig, Ohana Capital - Transcript


Tell us a little bit about how you went from previous careers to now buying or investing in searchers, and why you decided to invest in searchers versus buying the companies yourself.

It's been a meandering road to get to this point. Coming out of college, I started out as a management consultant, went back to grad school after a few years, knowing that I wanted to do something a little bit more entrepreneurial, that was in 1998. So, the original internet bubble was still expanding, it hadn't yet blown up. And I was looking at all sorts of entrepreneurial things to do when I was in grad school. And somehow, in that era, I stumbled across search funds, and the light bulb went off. This is an amazing model, there's people out there that would actually fund somebody like me to go out and buy a business and run it. And I thought that was pretty incredible, I got pretty excited about it. I did whatever research I could at the time, it wasn't like today where you can just go to a website and dial it up and watch tens of hours of videos and case studies.

You actually had to mail things and send away for it. And so, I did that, I wrote to Harvard Business School. And I think, there were three or four case studies at the time that they sent me. And then, Irv Grousbeck, who is the father of search funds, had relocated to Stanford. I wrote to his office, they sent me some more materials. And I was thinking seriously about raising a search fund at the time. I was at the University of Michigan, which was not the hub of search fund activity. It was still, at that time, largely Harvard and Stanford, and a little bit of Wharton. And ultimately got sucked up into the internet vortex and moved out to Seattle after grad school and joined a venture backed startup. That, like many of the companies of that era, raised lots of money, and then, very quickly imploded.

And I spun out of there with my first entrepreneurial venture, bootstrapped a small online publishing company. So, finally, a couple years after grad school, got to fulfill that entrepreneurial itch. And did that with a partner, it was modestly successful. We were generating revenue, we'd identified a good market niche. But, I don't think either of us really had our hearts fully into it, and it was a fairly small market. So, around that time, I had gone down to San Diego to a friend's wedding, met a woman, we were getting more serious. My business partner at the time, said, "I'm thinking about going back to grad school." So, the tea leaves were indicating that we were probably not going to run full steam ahead with the venture that we had started.

So, we sold it off, I moved down to San Diego, got involved in real estate for about the next six years, doing all sorts of things with my wife's family. And we had good timing, this was 2001 to 2007 timeframe. So, everything that we touched was turning into gold, and it was a lot of fun. I was learning a new discipline and it was really exciting to have a physical product that we were working on all the time. And that was a great run. And then, the last couple of deals that I was involved in, it was very apparent that we were headed towards change in the market and things were not going to be as rosy over the next few years as they had been for the previous few years. So, I had good timing and was able to get out of the real estate market and wasn't sure what I was going to do next, I ultimately decided that I was going to do a self-funded search.

Started to ramp up those efforts and just go look for a small business to buy on my own. I'd been successful enough in real estate, that I had a little bit of capital that I could scrub together to use as a down payment on a business. And as I started to get more serious about that, I sat down with my wife and I said, "Would you be on board with this? I'm not sure that we're going to be able to stay in San Diego if I go down this path, because I want to find a really good business and I don't want to be looking for ever to do that." So, bless her heart, she said, "If that's what you really want to do, I will do it." But we just had our first child a few months before and she was nesting, and her whole family was in San Diego. So, there was a lot of inertia to stay put.

And so, I said, "Before I commit this down this path, let me just take a pause, and see if there's something else that I can think of that would keep us here, that would allow me to still fulfill this ambition that I have of going out and owning a business." And as I was going through the list of possibilities, I remembered search funds. And I thought, "Oh, that's still a really novel idea. Maybe I could be an investor in search funds, rather than an operator. That way, I'd get to stay in San Diego, taking the amount of capital that I had, I'd get to spread it across a range of businesses, instead of a single business." And I'm a business junkie, I love learning about new businesses and the way people that have figured out to extract a living from what they're interested in. And it was a path towards me being able to learn a lot in a very short period of time.

So, I started to reach out to people in the search fund community, they were incredibly gracious, it's a super collaborative model. They welcomed me with open arms. And I had really good timing, this was early 2008, when the prospects for MBAs was not as healthy as it was a few years before that. And Stanford, every other year, publishes a research study that touts the returns across the asset class. And the results that year were extremely high, driven by a few large outcomes. And the New York Times started to gather some interest in the space and wrote a couple of pieces about the search fund model. So, there was this explosion of interest around the same time that I was walking onto the stage, which is good, because I had no relevant background really to the search fund model. I hadn't gone to one of those top business schools, I had never raised a search fund myself, I didn't come out of private equity. But I just had an interest in it, and I knew about the model.

So, as I was pulling all that together, I had a few friends and family say, "Hey, if you do this, we would love to contribute some capital." And some of the people on the investor side that I was speaking with, said, "Here's some deal flow." And before I knew it, with very little effort, I was in business. I started a small operation called Ohana Capital, raised first fund of friends and family money and hung out my shingle in 2008 and started to invest. And that's largely what I've been doing for the past 10 plus years now, is staying active in that community. So, it was really more driven by lifestyle than anything else.

So, you didn't go through the analysis of, what does my financial picture look like if I invest directly in the companies, versus just investing in the search funds? It sounds like it was more of this investing in search fund just gives you more flexibility, where you can live and gives you... Is it true that you don't have to do quite as much legwork, if you're investing in the searchers who are going out to find the business, versus going to find the business yourself?

It's a different kind of legwork. But, arguably, yes, that's true. A traditional private equity firm that does all of its own deal sourcing has all of that in-house, this is more of a distributed model, where the backers of the searchers in that private equity field, outsource to these ambitious MBAs, all of the legwork of going out and identifying the company, negotiating and structuring it, which is the lion's share of the work from an hour standpoint.

So, is your day-to-day mostly focused on working with your existing portfolio companies through searchers and helping them operate businesses? Or, is it pitching to new searchers? Or, are they pitching to you in the opposite direction?

It's more inbound in terms of the deal flow generation. So, the community of investors in the search fund market is still pretty small. There's a handful of dozens of them at this point, and they're pretty easy to identify. You can go to other search funders websites and see who their limited partners are. And if you do that enough times, you develop a pretty comprehensive roster. And if you talk to other searchers, you can get their contact information pretty easily. So, a lot of the deal flow from an investor's perspective tends to be inbound, you can go out and beat the bushes and go to business schools and talk to people and raise awareness even higher, and generate deal flow that way. But, it's not terribly necessary, I find. And then, a lot of the rest of the day-to-day is evaluating searchers, helping them during the search.

And then, after the search, whether it's in a board capacity or just as an informal advisor or an investor about particular areas where you may have some expertise and relevancy.

Search funds have become much, much more popular over the last few years, has that impacted your ability to invest in search funds at all?

I'd say, the growth has made it easier, I have actually reduced the frequency of investing in search funds that I've done over the past 10 years, over the past couple years. But, there's more search funds than ever, so, to have an opportunity to put capital to work for an investor right now, it's better than it's ever been.

So, the searchers are pitching to you as the investor, not the other way around? I.e., there's more supply of searchers than there is capital to invest in them, or investors to invest?

I think people are looking for a match, ideally. And that's how it works in the best cases, where, a searcher or a team of searchers is evaluating an investor or a group of investors, and the investors are likewise evaluating the searchers. So that, hopefully, they find a connection there that will withstand a long duration of a relationship. I mean, a lot of times, it has gone for a decade or more.

What things do you look for in your searchers? Or, characteristics that you're seeking out?

I think, humility. Most of them, in terms of just raw intellectual horsepower, they have that in spades. Just, I think, self-selecting into the model, they have enough common sense and know-how and they're adept learners. So, charisma, I think, and some ability to sell or persuade, I think is vitally important. Work ethic is really important. Humility, sense of curiosity, I think those are some of the main ingredients.

How do you know if a searcher is going to be a good operator? Do you know based on... Or, do you look at their prior experience that they've had in operator capacities? Or, if searcher hasn't had any operating experience, how do you evaluate whether they're going to be a good candidate for you?

I don't know that I can do that, it's a really difficult thing to do. Yeah, I don't know that my predictive abilities about who's going to be a good operator are anything more than throwing darts at a board. And it also depends, not just, will they be a good operator? Will they be a good operator for the business that they ultimately acquire? It could be that in a different situation, they would be much better or much worse than what they actually end up being, because of the fit between them and the market and the people in the company and the customers that they have. So, you really need a lot of stars to align, but some people, obviously, are just generally better at it than others. And you get two years, roughly, that's about the average time it takes for a searcher to find a business, to oversee and watch and make your own determination about what kind of an operator you think they'll be. And nobody's perfect, everybody has gaps in their skill sets.

And so, it's also helpful to understand those, so that maybe you can work with them or help them identify resources where they can fill in those gaps, so that you bolster them in areas where they may need some more development. But, a priori, being able to identify who's going to be a top-notch operator, a lot of times, it's very difficult.

Do most of the MBAs and searcher candidates you look at, do most of them have operating experience? Or, is this the baseline to have generally some experience in corporate environments, but not necessarily small business ownership and operation?

Almost none have small business ownership and operation experience. They all have work experience, I would say. But, not even always leadership experience. Sometimes they'll have managed to one or two, or a handful of junior associates. Some people that come from more operating intensive roles will have had an opportunity to lead larger groups of people, or people that come from a family business background may have grown up around small business. But, more and more, there's a real diversity of backgrounds and skill sets among searchers.

Can you walk us through some of the history of the search fund model, both as a searcher and an investor? I remember on our phone call, I asked you a little bit about it, and you had a great breakdown of the 20 year history or so. Would you be able to share some of those points?

Sure, yeah. And my experience doesn't go back 20 years, so, some of this is just what I've gathered, and it may not be entirely accurate. But, I believe the first one was raised in 1984, and that was a very successful search fund, ultimately, I think that one had a very long life and returned significant multiple of capital to its investors. And from there, for a long time, I think, it just was one or two new searchers a year, maybe not even every year. Largely driven by Irv Grousbeck, first to Harvard, and then at Stanford, who was very much a mentor to the initial searchers. Worked closely with him, first as a professor and a student, in that relationship.

A lot of times, then, they would come on and become case writers, after they had graduated. And wrote about small business issues or things that Irv was interested in. And from there, they would move on to actually running a search fund. And then, I think, some people in those communities, on the investor side, started to be brought into those deals, to be able to co-invest and to participate, maybe that started from day one. And it remained very much a very strong mentorship model, where there was a lot of very close collaboration and connection between the LPs and the searcher. Then, as the model started to expand and more searcher started to do this, the connection became a little bit harder to maintain.

And I think, over the past five or 10 years, that's been one of the themes, is that, investors portfolios have grown very dramatically at any given time, having a small stable of search funds in their investment portfolio to, some people now probably routinely have 40 or 50 or more, and there's collectively people that have invested in over a hundred search funds. So, when your portfolio of companies expands the size, I think, just by the virtue of the large number of investments that people have, it becomes harder to have oversight of those. And so, the searchers, I think, started to see more dispersion among the investor base, they weren't getting quite as close to the connection, there's also been a rise of a more institutional class of investor out there, that have brought a lot of value to the community.

But it's also changed a little bit, they write larger checks, they have the ability, I think, to influence outcomes, perhaps, in some cases. A bit more search funders come from a much broader array of schools than they used to. And so, they have, I think, less of the ingrained culture sometimes. But, there's also a lot more information available, and there's a lot more searchers to connect with. So, the information has also become easier to access. It's a maturing asset class, which is really exciting in a lot of ways. And there's starting to be permutations of that, there's groups that are accelerators out there now, that are running cohorts of searchers under one umbrella. There's people that are seeking out single limited partner relationship, so they don't have a distributed investor base, it's a very concentrated investor base. There's people that are starting to specialize by geography a little bit more, or by industry type.

So, there's really been an explosion over the past five plus years, of a lot of diversity within the model, which has been great. And then, macro factors over the past, for at least, my investing time period, we've been in a long bull market, credit is much more available now than it was when I started, when we were in the depths of the recession. And there's a lot more interest in software businesses and SaaS businesses than there used to be. Sellers are much more educated about the M&A marketplace than they ever have been. Technology tools have greatly impacted search funds and allowed search funds and intermediaries to reach out to larger numbers of sellers than ever before. So, the old situation where maybe you would run into an old retiring seller that had never been approached before is becoming much harder to find than it used to be.

I mean, if there's seller that hasn't been contacted by an intermediary or a prospective buyer, at least, once a week, if they have a good business, that would be surprising today, I think. So, there has been a lot of change in the marketplace, in the lower middle market, which is how a lot of people define this range of businesses as one to $3 million in EBITDA, has become a lot more liquid over the past 10 years than it was before that. And so, I think, the level of competition for each deal has gone up over that period of time.

Yeah. How do you differentiate yourself when you're trying to contact and buy from owners who are getting a call or email once a week? How do you make yourself look different?

It's challenging. I think, searchers can still differentiate based on the fact that they are buying a single business, it's not a portfolio play. They've got an experienced group of investors behind them, they won't have a long-term mindset, there's no fun to driving them to sell within a certain time period. And then, they can also differentiate based on expertise. If they pick an industry sector and really decide to go deep in there, they can develop relationships, they can learn the ins and outs of the industry, and I think, separate themselves from the crowd, by knowing more about a particular seller's business before they even approach them, than another buyer might.

Are searchers able to get proprietary deals? Or, do they just need to knock on enough doors and differentiate themselves that way? And if they do, do most owners respond to those advantages? Or, are the vast majority of owners, they just don't care, they just want the largest check?

I think owners are individual people and they all want different things. To many of them, especially owners running bootstrap businesses that they founded and have led and have seen through really tough times and really great times, there is an emotional attachment both to the business that they built and to the people that work there, the customers that they serve. And so, they don't want to just sell it to the highest bidder, although, some people are just motivated by that, and that's what's important to them. Or, other people, maybe there's a catalyst that's forcing them to sell with some degree of urgency. And so, the certainty of close becomes really important. Other people don't have a family member that they can have as a successor to them, and they see a bright, young, ambitious MBA, as the child that they didn't have, that loves their business. And so, it's a very emotional sale. And so, that helps in that case.

So, there's probably as many different reasons about why people sell and who they sell to, as there are business owners.

And you mentioned that there's a few searchers that have a single LP model. Along that spectrum of single LP to diversified investor base, where do you prefer to land with a searcher?

Well, I don't have the balance sheet to be the single LP, so, I can't land there. And I've only worked in the search fund community where there's a fairly distributed limited partner base. And I think that works well. It's what the model was founded on, and I think it continues to be a model and a structure that works well for both investors and searchers.

Yeah, I'd imagine with the diversified base, you get just more experience that way.

Exactly, right.

Are there some disadvantages that come with that, that you don't get with the single LP model?

I think from the searcher perspective, there's always a question about, will I be able to raise the capital? Right? If everybody's writing smaller checks, will I have a gap? And if it's a strong deal, those gaps inevitably close. But, the other disadvantage potentially is, if your LP base is too large, you spend more time doing investor relations, than you do the actual activity of searching or running a business. Other than that, I can't really think of too many downsides.

I'd imagine, with a single LP, you're limited in that, all your risk is concentrated in one investor, from the searcher's perspective.

Right. If you find a business that they don't like, and they say, "No, we don't want to invest in this," you have to then go out and raise the capital with a fresh group of investors that don't know you as well.

It leads to a discussion around the search fund accelerators, which are becoming more popular. Is that a similar disadvantage with search fund accelerators, in that, an accelerator might be your only investor? Or, there're just investors behind the accelerator?

I'm not familiar enough with... There's a few accelerators I'm familiar with, but I'm not familiar enough with them, to know how those deals get funded inside those entities. Some of it may be a deal by deal case, where they pass the hat to their group of limited partners. Other case is, they raise funds, and it's probably at the discretion of the accelerator operators. And in that case, it probably is more similar to a single LP, where you incur the same or similar types of risks.

Are there trends today in search fund investing that get you really excited, or you're really been focusing on the last year or so?

I think it's exciting to see how many searchers there are out there now, just the growth in the model in general. There's this aging baby boomer demographic, many of whom are business owners. I think, the statistics that I see thrown around is there's about 300,000 businesses in the size range that most search funders target. And virtually, all of those will turn over in the next 20 or 30 years. So, there's a tsunami of M&A opportunities that are out there. And the search fund asset class is still relatively small, relative to the size of the opportunity. So, I think it's just exciting to have more people being drawn into that marketplace, because it creates more opportunities for those businesses to transact successfully and for those legacies to carry on to a new generation.

Yeah. How much do you see the baby boomer retirement wave in your day-to-day?

Oh, all the time, regularly. Yeah, it's a significant portion of deal flow. Where, I think, it's less common is with technology and software based businesses, where the ownership tends to be younger still.

And do you have a preference or any investment thesis on SaaS technology companies versus more blue-collar home services type company?

The traditional set of search fund criteria aligned very, very well with SaaS businesses, recurring revenue, lack of customer concentration, strong margins, growing markets, the list goes on and on. But, it's a very tight fit. So, all that's really attractive. But, you're oftentimes competing in markets where there are other very well financially backed competitors, with smart people running them or smart people backing them, the risk of technology obsolescence is high, the valuations tend to be much higher.

So, if you buy into, in my case, in particular, the valuation component of it, I think there's a lot of tremendous opportunities there, and there's a lot of very niche marketplaces, or software companies rather, that serve different marketplaces very successfully, that are under the radar and they're never going to grow up to be Salesforce or Google or whatever other enterprise SaaS company you could name of, or Workday, constellation brands does a lot of that kind of acquisition, or Vista Equity, maybe slightly larger, but same sort of model, and they've done that very well. And I think it proves the thesis that, these are sustainable, enduring businesses with very strong underlying economics. But the valuations tend to be very, very rich. You're getting a lot of times into revenue multiples, instead of cash flow or EBITDA multiples.

And as long as those multiples hold, I think people will continue to do well. And they've held for a long time, so, there's probably no reason why they won't. But I think, particularly, if you come out of like a value investing background, it can be hard to make sense of why people are paying what they are for those companies.

Have there been a few business models over your career that you've become familiar with, and are, maybe not, you specialize in them, but you look for searchers who are also interested in those types of companies?

I think, the search fund asset class in general has historically focused on recurring revenue businesses. Initially, I think, there was more of a mix between manufacturing and service, with little bit of technology. Now, I think, there's very little manufacturing, a lot more service, and a lot more technology or technology enabled services. And so, I think anybody that spends a lot of time in the asset class tends to develop pattern recognition around businesses in those areas. And the recurring portion, that operates on a continuum too. It could also be from long-term contracts, subscription revenue, or just highly repeating revenues, that all resemble recurring type businesses.

And switching gears to the investor side for you, what does your investor base look like at Ohana Capital today? And have you raised multiple funds at this point?

I've been involved in raising three funds, but Ohana Capital today is largely just me using my own capital. And as I mentioned earlier, I've significantly slowed the pace of activity, and that's allowed me to just use my own capital, rather than going out to limited partners.

So, the amount of your own maybe permanent capital has increased over your career, generally. And so, what does that give you the ability to do that having investors, maybe, made it harder to do?

I don't know that it's done anything differently. The funds that I was operating were very, very small, probably, sub-optimally small. Because, the administrative burden fell on my shoulders, rather than being able to outsource to a third party. And so, again, sort of come back to lifestyle. Just not having to manage the investor portion of things is more enjoyable to me. Although, there's a lot of gratification that I get working with a group of investors that I've had, and being able to deliver a good results to them. That's a nice external validation that the work I'm doing is meaningful beyond just me. But, the back office, in particular, was a part of the job that I never really enjoyed. And so, not having to continue to do that, has been a nice upside to using my own capital.

Switching mainly to your own money, has that been a pretty easy, nice transition?

Yeah, yeah, it was, get to the point where you say, "Am I going to raise a new fund? Or, am I going to not raise a new fund?" And I just decided that the last moment when that would have been probably the right window to do that in, that I was not going to do that.

Is this long activity just because you're using your own money and there's not a fund behind you? Or, is it that it's become harder to find companies that are attractively valued?

Part of it is definitely driven by valuations in the current marketplace. I'm not abandoning the search fund asset class, I still have probably investments in 20 companies there, I've still got a handful of active search funds that I'm involved with. I continue to back new searchers, but at a slower pace. But, valuations have continued to rise. And so, all those being equal, you would expect returns in those investments to be lower than earlier cohorts, where the valuations were lower. I've been focused more of my time now on looking for opportunities directly. And so, over the past couple of years, I've actually ended up starting a small business with a partner. And then, recently, back in March, bought a business with the same partner, that was an operating business in a going concern. That I found it, what I thought was a good multiple for a very solid business.

Is that what you see yourself doing in the future? Is buying these companies directly and continuing the trend of investing in searchers less? Or not, maybe not at all?

I don't know. No, I think, there're probably different legs on a stool. So, I like the search fund community, I've spent 10 years of my life in that community. I love working with the searchers, and it's a great group of other investors. I don't think I would ever want to completely walk away from that. I like also owning these businesses and being able to be a little bit closer to the action, from an operating perspective. And having a little bit more input into the way they evolve. And if, wherever to exit, when they exit, and to whom. And so, it's a nice balance, I like all of it. And so, I think, I'll continue to just be opportunistic. And where I find opportunities that make sense for me and where I'm excited about them, that's where I'll direct my capital.

All else being equal, is the direct investing... What kind of advantages does the direct investing have, over being the search fund investor?

I think there's a lot of differences. One that was important to me was being able to really pick the industry and the size of the company. So, search fund investors or search funders usually look for businesses with, at least, a million and a half dollars of cashflow a year. And investing in my own behalf, I can go to a smaller sized business in that, where I still see a lot of potential. And the valuations in the smaller businesses in today's market make a lot more sense to me than the businesses that are somewhat larger. But I think that the activities really help one another, at least, in my mind. When I'm out there searching for my own deals, I'm essentially acting as a searcher, and developing, not only the skill set, but a lot of empathy and ability to then help other searchers, when I'm acting as an investor in their funds. Because I'm closer to the operations in these businesses, I'm not the acting CEO of the businesses, where I have a larger ownership share.

But, I see a lot more of the daily issues again, that the searchers, once they become CEOs have to face every single day. And so, my currency of knowledge about all of those things, how do you choose a payroll provider? What's going on with insurance? Or, what about different personnel issues that they might be facing? Those are things now, in the businesses that I own, where I have a lot more transparency and I have to wrestle with some of those issues myself. And so, when a searcher approaches me with those, I feel like the counsel I give is maybe a little bit more grounded in more recent reality.

Is that some experience that you wish you'd had, when you first started investing in searchers? Just to be more helpful to them or to empathize better.

When I first started investing, I did have it pretty recently, because I just come out of that real estate environment, where we were running real estate operating companies, as well as doing real estate investing, and it was a small business environment. So, I felt like I was still pretty close to being an operator. But then that bled off pretty quickly. And after a couple of years, because I hadn't been operating anything, I think, I lost touch with some of the things that operators have to deal with on a daily basis.

And today, in your current searchers, who own businesses at this point, how involved day-to-day are you with them? I imagine, it's more actively involved in the first maybe a year or two. And then, when you're in the years, six, seven, eight, maybe it tapers off more. Or, maybe I have that wrong.

Not necessarily, no. Really, I think the bigger distinction is whether or not, I have a board seat or not. And if there's a board seat involved, then the level of activity is sustained throughout the ownership period of that business. If I don't have a board seat, largely, it can be fairly passive, unless there's some particular thing that comes up with the searcher/CEO at that point. Where, maybe my background or experience or network would be of value. But, a lot of time, it's the board that works most closely with the searcher.

Do you generally want a board seat?

No, no. For some people, it's more important to them, or they're writing checks that are large enough, and perhaps they have funds where there's a fiduciary responsibility, where they feel like they need to do that. But, I try to only go where I feel like there's a very clear way that I can add value, and to not have any ego about it. There's a lot of really talented investors in the search fund community, oftentimes, were much better suited to serve on the board than I am. And as an investor, I want the strongest board that we can possibly assemble to be the ones that are working on that investment.

Yeah. How do you assemble a board for a searcher that's going to be the most helpful to them?

I think, the searcher is in the best position to evaluate that, because they lead the diligence on the company. So, they start to understand what the company needs. They also probably have the best knowledge of themselves and idea of what they need as a leader and as a CEO. And then, there's some external realities that factor in it. For example, I mentioned before, somebody is writing a really large check, there's a reasonable expectation that they should have a board seat. And so, in that case, the searcher may not have a lot of discretion over that particular person joining their board. But, the search fund investor community is filled with wonderful people, and there's almost never a bad option out there. So, you're generally choosing between a host of very good options.

If somebody has extra capital that they want to invest, and the public markets aren't necessarily as interesting to them, and they like the search space, what's a good way for them to start the process of becoming a search fund investor? What does that timeline or process look like for them?

There's probably two ways to do that thoughtfully. One, you have to have enough capital, that's discretionary, to be able to just go out and invest on your own. And that probably is in amount in the millions of dollars, to build enough diversification to mitigate some of the risks that you take on investing in these smaller liquid investments. The other way would be to search out probably one of the funds that have popped up, wait for them to raise a new fund, and then, go to them and express interest in becoming a limited partner in what they're doing. And then, a third way, I suppose, where maybe you do take on a little bit more risk is, just start to plug into the community, get to know those people, and then, very selectively, make a handful of investments and just acknowledge the fact that you're probably going to be overly concentrated in a few of them.

And then, ride those out, if your capital doesn't allow you to continue investing. And hopefully, have good outcomes, and then, recycle the capital.

Have you had a few of your earliest searchers exit at this point?

Oh, yeah. No, lots of exits.

How have those turned out? Have they been pretty positive?

Yeah. Overall, very positive. Yeah, the returns from the search fund asset class, and anybody can go online and look at Stanford's bi-annual report, are phenomenal. I mean, it delivers really attractive returns. Not without risk, and certainly not without illiquidity. But, overall, I think it's a healthy asset class. You're taking small businesses with strong cash flows, applying a bit of leverage. And, as long as nothing really goes wrong, even if you just pay off the debt, you'll generate a sufficient return to, I think, justify the exercise.

I think you mentioned a little bit of this earlier, but, how are you seeing larger private equity firms enter the search fund space? And is that creating more competition? Or, are there just so many searchers that it's still not as big of an issue at this point?

Probably more competition at the margin. But, the private equity firms that are entering the space, are not private equity firms, at least, that I'm aware of, that are doing a lot of investing outside of search funds. So, they're very specialized. They're funds and companies that are formed specifically to invest only in search funds and the resulting acquisitions. And so, the fund size is relative to what most people would think of as the private equity firm universe, are still modest. I mean, it's still tens or into the hundreds of millions of dollars at this point. But, still small, there's not billion dollar funds being raised to invest in search funds today. And like I said before, every deal is a syndicate, it tends to be a very collaborative environment. And the searchers themselves, in many cases, don't want a super concentration of their investor base.

So, those funds that specialize in investing in search funds, may buy, at most, maybe 20 or 30% of a searcher's available units, in their search fund. And so, it's not even a majority share. So, there's still plenty of opportunity for other seats to be filled by individual investors.

Do you think some firms will find a way through quant strategies or better technology to invest in companies that are of this small size and arbitrage that multiple advantage away?

I don't know if you can arbitrage the multiple advantage away. I suppose, if you're talking about increasing the level of activity, we will see multiples rise, they already have risen, whether or not that's systemic or just related to the bull market in general, I don't know. Parts of the model are already moving in that direction, to be more quant like, I think. And there's available databases of businesses that people are drawing on. I mean, a search funder now has an incredible ability to reach out in a very automated fashion, to a large number of businesses that wasn't possible even five years ago, right? And maybe five or 10 years ago, a searcher would think, "Throughout the course of a two year search, I will contact 2,000 business owners, of which, I will have meetings with X percent, and I'll get to a letter of intent with Y percent, and I will close on one deal."

Now, that might be 10X. Because, you can automate these email streams, you can hire a team of interns to do the research and pull together the contact lists. And there's the availability of the data that wasn't there before. So, that's just the first layer. I think, if you really wanted to make this a quant exercise, you'd need to go deeper and figure out ways to develop proxies for revenue and margins and health of things, and do industry analysis and create a database of that, that all feeds together and ties in. And really, makes it a mathematical exercise. And that would still probably only carry you so far. But if you invested in enough of those businesses just based on the numbers, you would probably still do okay. But, again, ultimately, this is going to come down to people, and you have to convince the sellers that they should sell to you.

And I'm not sure, how many of these small business owners would sell to a quant fund, that doesn't have really, at least, from an outward birth parents, any emotional connection to what they're doing.

What kind of tools are you seeing being used to gather data quicker?

The databases out there like Capital IQ or Hoovers or other ones that collect small company data, is one way. I think, probably the biggest change that I've seen over the past handful of years is in the ability to reach out to those businesses, once you've collected the information. Rather than having to go in, one by one and create emails, and then remember to follow up three days later or a week later, and then just place a phone call in, or things like that. There's email automation software out there now that allows you to build those sequences, and have it be very automated. Where you can say, "I'm going to run seven emails over a two week period, and it's all going to happen without a single keystroke from me, unless somebody replies. In which case, then, I manage by the replies by exception, and that's how I'm going to be real efficient."

And so, that allows you to load in a thousand contacts, and email those people every day, for as many times as you want, over the period of time that you want. I mean, you can literally flood people's mailboxes with very little effort.

What are the success rates for cold emails? What does those percentages look like? So, of the 2,000, 5,000 companies that are emailed on that list, roughly, how many reply or how many are successful?

Depends on the person crafting the campaigns. And I think this is true in business cold emailing generally. And I think, over time, I think, the response rates have gone down. When it was a novelty, there was a book called Predictive Revenue, that I think kicked off this latest surge. It was written by a guy named Aaron Ross, who came out of Salesforce, who seems to me like the pioneer of this cold emailing approach. But I think, even in some of my early campaigns, I would get response rates of 50%. That was exceptionally high, I think a much more normal response rate, if it's a well crafted email campaign, is probably somewhere in the 10 to 20% range.

Wow, that's pretty high.

It is high.

I was thinking like, 1, maybe 2%.

No, you can do much higher than that. You've highly targeted, you're appealing to a CEO or a business owner, you've got a very compelling pitch, right? That, "Hey, I'm interested in your business and I might want to buy it." I think that's a pretty compelling thing to try and reach out to somebody about, as opposed to, I'm selling XYZ widget, and there's 50 other competitors out there, those are the kinds that are very easy to quickly just hit Delete. But, even though the number of inbound emails that owners receive from potential buyers or intermediaries has gone up, it's still not as high as lots of other kinds of business emails that people are receiving.

So, how do you make a well crafted cold email to an owner?

I don't certainly have a monopoly on how to do this. I think, what's worked best for me is to try and really put myself in the shoes of the business owner, and talk to them about things that are meaningful to them. And that's in contrast to reaching out to them, telling them about me. So, I'm not going to reach out to them and say, "Here's three paragraphs on me and my background and why I'm so great, and I think you should have a conversation with me." I'm going to reach out to them and appeal to what I think might be issues or problems that they're facing, that I, as an investor might be able to help them address.

Is there some way to customize an email based on the industry it's in? So, you send a specific one for every landscaping company, and then, manufacturing, a different type of email?

Absolutely, absolutely. You can get very nuanced. And you can do, if you want to take the effort and develop little snippets of really customized information that you want to insert into emails, it just becomes a cell in a spreadsheet, that then has a header tag on it that you can then pull in as a variable to the email program. And it could be a single word, it could be a paragraph, it could be a sentence. It could be related to a conference that you just attended, where they were presenting or exhibiting, they were, maybe you connected with one other people. Or, about a blog post that you read. And all of that could be just a field in a spreadsheet, that then gets pulled in as a variable to a customized email.

So, of the 10 to 20% of emails that come through, how many of those usually follow on to-

A conversation?

Yeah.

20 to 50%, depending on what industry you're in, and how targeted it is, and how compelling your pitch is. I mean, a lot of it is, no, thank you. But, a lot of people, even just to have the [inaudible 00:43:55], will say, "Yeah, let's have a conversation." And it might only last 15 or 20 minutes, but, it's a conversation. And then you start to build a relationship. And even if the time is not right now, if you're a searcher, it still could be within the timeframe of your search, that, maybe they decide to sell. And there are private equity firms, Summit and TA Associates are probably the most well known, that have very active direct sourcing programs.

And one of the things that they have as an advantage, that searchers don't, is that they develop the same process, largely. But, they can maintain those relationships infinitely, in duration. And so, if a business owner says, "Great to meet you Summit or TA, I'm not ready to sell today." They can track that and continue to reach out to that person over five, 10 plus years, until the person is finally at the point where they say, "Yeah, I'm thinking of selling now." Whereas, a searcher has typically a two year window.

Yeah, must be quite the advantage. And then they plug in a CEO or a... Do they go find a searcher and say, "Hey, I know you want to do a search and do this on your own, but we have this business, do you want to come and run it?"

No, the businesses they target are typically much larger, and they've got established management teams in place. And oftentimes, those businesses are not even founder run. And so, it's professional management at that point. So, they don't have to deal with CEO succession or turnover quite as much as the search funder would.

Have you met some searchers, who, they want to buy one business but they want to build their own portfolio of businesses? And is that something that, if you like them, you're willing to help them do that? Or, have you had that happen to a searcher?

Yeah, absolutely. I think, what I've seen most frequently is a searcher, or a team of searchers, because sometimes there are two of them, will go out and express an interest, even at the outset saying, "Long-term, what I want to do is, I want to own a portfolio of these companies. But, I really like operating, so, I want to operate a business and I need more experience there. So, I'm going to do a search fund, and I'm going to try and generate a great outcome for myself and my investors. And then, see what phase two looks like." And so, what I've seen is that people go out, they do that, they buy a business through the search fund model, they run it, they grow it, they have a successful exit.

Now, they've got more capital than they had at the beginning, and a good track record with a group of investors, who also have capital. And then, they can go out and start to execute on that plan, and try and build a portfolio of companies. Where, they're still probably fairly actively involved. But oftentimes, not the full-time CEO any longer.

Would you help them with those other investments as well?

Help them in the sense of writing a check, Yes. But, a lot of times, at that point, they're tremendously experienced already. They're good operators, they're good investors, they've got a toolkit that is pretty strong. And so, what they really need at that point is, I think, still, a sounding board, everybody likes to have smart people around them, to help clarify their thinking and stress test their judgments. But, a lot of times, they just need to have the capital to execute on their plan.

Does every searcher have to exit their investment just as a result of the capital structure they have? Or, are there often clauses where, or, parts of a contract that say that the searcher can buy out an investor's interest over the life of the investment?

I haven't seen clauses like that, but there's no predefined hold period for a search fund investment. So, they could theoretically hold it forever. I think, investors might start to get antsy and they might look for ways to create options for liquidity. So, you might recap the business and allow people to exit, that's happened in some cases. Or, there'll be a rights offering, where somebody says, "If you'd like to tender your shares at this price, or create a mini auction model to set the price, then, we have some excess capital and we will selectively buy people out on an as available basis." A lot of times, though, the decision to exit or monetize some of the value that's been created is driven by the searchers.

A lot of times, when they start their search fund effort, they're relatively young, late 20s, early 30s. Relatively unencumbered, they don't have mortgages, they don't have families, they don't have children and things like that. And they also don't have a lot of net worth. As they're successful in their endeavor to build their business, they all of a sudden have net worth, but it's highly concentrated and highly illiquid. And oftentimes, they're moving into a different phase in their lives, where they have a mortgage, and they have a family. And they want to provide some security and take some chips off the table. And they will oftentimes approach their board, and say, "Let's have a discussion about how we can create some liquidity for us here." And there's a number of ways that they can do that.

If you could go to college and teach a class on literally any subject you wanted, that was just interesting to you, what class would you teach?

I think I would probably want to teach effective communication. And the components of that are both listening and communicating. I think, great listening is almost a superpower. It allows you to relate and connect to people, it allows you to learn very quickly. And then, being able to communicate back in an effective way is its own superpower as well. I think, being able to articulate things in a way that other people hear, in the way that they're intended, without raising emotions to a way that they start to interfere, is really helpful. I mean, it's an area where I've spent a lot of time trying to develop my own toolkit over the past few years. I feel like it's still got a long road ahead, but the mine there is really deep and rich.

How do you think you would organize the class?

Probably try and find texts that I think are highly relevant, that would be the cornerstone of the teaching. And then, try and develop some experiential exercises built around the themes in those texts. I finished reading a book recently called Nonviolent Communication, which is a funny name. But, when you read it, it makes a lot of sense. And it's really talking about how to communicate with people in, what the author calls, a nonviolent way, which is a way that really respects them as individuals, and also respects your own feeling. There's another book that I read, it's much more business oriented, called, Radical Candor. That came out maybe a year or two ago, developed by a woman who had done a lot of leadership training at Apple and some of the other Silicon Valley companies, about how to communicate transparently and candidly, but also with compassion.

A lot of times, in business, you have to deliver tough news. And I think, there's definitely an art to doing that in a way that respects other people as human beings. Another book that I would probably add to the syllabus would be Chris Voss's, Never Split the Difference. I don't know if you've heard of that one. He's the former head of the FBI's hostage negotiation team. And in business school, we read some negotiation books, Getting to Yes, probably being the most well known. And he turns a lot of the learnings there on their heads. And he was in an environment operating, where, if you fail, people died. Right? So, the stakes couldn't be higher. And he and his team had to figure out what really worked in high stakes negotiations. And it's just another form of communicating, and reading the situation there to communicate effectively, in a situation where the outcomes can be really high.

What's the most fortunate event that happened to you, that was completely random?

Winning the genetic lottery. I think, being born to U.S. citizens in our modern era, is probably the most fortunate really random thing that I could think of, everything else is flowed from that. And having spent a fair amount of time traveling, and just seeing the differences that the circumstance of your birth can create, and the outcome of your life, there probably is no more truly random event that has a large impact on my life, and I feel like I've been super fortunate. The backup answer would be meeting my wife at her brother's wedding.

Where have you gotten to travel?

I started doing some international travel when I was in high school, I spent a summer living in Spain as an exchange student. Then, in college, I spent a year living in Bogota, Colombia, with the families, with my sophomore year abroad. And then, one point I did some backpacking around Southeast Asia. And then, since I've been married with my wife, we've traveled to Central America and Europe and Asia. And my wife and her family are avid, avid travelers. So, every opportunity she gets, she drags us all over God's creation.

Give a few notable stories from your travel. Because, that's a lot of different, very different places that you've gotten to visit.

Yeah. Probably are lots of stories from travel, that's one of the great benefits of travel is you come home with stories, in addition to memories, and sometimes souvenirs. But, my favorite travel experiences have been those more deep immersion situations, where I go and actually feel like I actually live someplace or feel like I'm living someplace, and really get to feel and wrap the culture around you.

Where did you feel like you were most enveloped in the culture?

Colombia, because that was where I spent the most amount of time, and that was during the era where Pablo Escobar was still alive. And the year that I lived there, it was 1992, 1993. So, he was in prison, and then he escaped from prison. And there was still a lot of violence on the streets, and he was basically at war with the government, during the period that I was there. And so, there were car bombs and witness killings and kidnappings, and judicial kidnappings and killings, and there was guerrilla activity. And I mean, there was a lot of turmoil in that country at the time, and almost no foreign presence. And so, it felt authentic, I guess, in a way. There weren't McDonald's and Burger Kings on every corner, there were very few other Americans traveling in the country at any given time. And the people were just so gracious and warm and wonderful.

So, it's just this really rich tapestry of contrast between the violence and the social upheaval there with the deep, traditional cultures that they have, that were centered around families and friendships and music and enjoying yourself. And it was just incredible.

Is there a moment or a memory that sticks out the most from your time in Colombia?

No, not a single memory. One anecdotal story that touches on the narco trafficking activity that was just a unique experience there, that I don't think I would ever want to recreate. But, there was an area of nightclubs in Bogota. And I went up to one of these nightclubs with some friends one night, and we were having a good time, dancing and drinking. And all of a sudden, the music stopped, and the DJ got on the microphone and said, in essence, good news, bad news. "Good news is that your tab has been paid for the rest of the night. Bad news is, nobody's allowed to leave until we say so." And then they turned the music back on, and word trickled through the club that what had happened is that one of these narco traffickers had come in and basically taken over the club. And for security purposes, said, "Nobody leaves until I've left." But, I'll cover the tab for the whole place."

He wanted to make sure that nobody else came in that he didn't know was already there. It was a purely security type thing, I would guess. I mean, I hadn't talk to him, but, I think, just making sure that he probably had people at the door, to make sure that nobody left and nobody came in. And maybe trusted the people that were already in there, were not people that he was going to be concerned about. I took the bus a lot then, routinely riding around the bus and see the narco traffickers. They all drove Toyota Land Cruisers with blacked out windows a lot of times, and the people driving them didn't look like people that would be driving fancy cars. But, there was, driving around, looking at the buses, and there'd be submachine guns in these people's laps. Or, you'd see, driving around in a taxi or something, and there'd be a big hole in the ground where a car bomb had gone off, or streets would be closed off because of things.

But, where I probably felt it the most, although, it wasn't a scary experience, was just in the restrictions on travel. Traveling by car outside of Bogota was really frowned upon. And it wasn't so much even because of the narco traffickers, it was more because of the guerrilla groups. They would set up checkpoints, and then, either kidnap people and hold them for ransom, or sometimes just kill them, if they found somebody that they didn't like. And Americans, because they thought we had money and we were also supporting the people that were fighting the drug traffickers and the guerrilla groups, were not generally well liked by those groups. So, we were high value targets, I think, in the eyes of a lot of those people. So, we got lots of warnings about, "Be very, very careful about where you go and who you're with."

And there was one story about an American college student that was down there that was a woman, she was driving with some Colombian friends. And they were headed just to a small town not too far outside of Bogota. And there was one of these checkpoints. And the driver said, "We can't stop, there's no way we can stop. Because, I'm afraid they're going to kidnap you or rape you or do something terrible to you." And so, they blew through this checkpoint and they got shot at. Shot back of the window shot out, and I think, maybe one of the people in the car got hit with a bullet, and it was serious. But, Bogota was also, at the time, a city of eight million people, and like New York City, probably in the 70s, when there was a lot of violence. As long as you knew, where to go and where not to go, and what time of day you could be at certain places, it was very safe city.

I never felt really under threat, even in that nightclub story, that didn't feel particularly scary. It was an ideal, but I didn't feel like somebody was going to come and kill me. When I was... You're going to think I lived with all life of danger as a traveler, but I really don't. Most of the places I go are extremely safe. But, when I was a senior in high school, I got 15 friends together, we rented two houses in Jamaica. And God knows why our parents let us go down there unattended, but they did.

Or to Colombia.

Or to Columbia, right. At least, then I was in college. I was a 17 year old high school student with 15 other high school boys, running two houses in Jamaica. While we were there, we got shot at and held up at gunpoint. Of course, we were such easy targets for these people, right? And so naive. The gunfight thing, we just were in the wrong place at the wrong time. We were walking through a place, where, I think, a couple rival gangs were just a couple blocks off of a tourist area. And they were across the street, like the old West, shooting bullets at each other. And we were ducking and dodging to get the hell out of there and get back to safety, we just stumbled into the wrong block. And then, getting held up was more our fault.

We met these Rastas and they were like, "Oh, we're going to have a party on the beach tonight, you guys should come down there, it'll be a lot of fun. There'll be drinking and weed and music." And we're like, "That sounds awesome, we're totally into that." So, we all go down there and we find them on the beach. He told us where they're going to be. And then, we were in a minivan, the minivan drives off and the Rasta comes up. And he's like, "Oh, great. You guys come, give me all your money." We were like, "What the hell are you talking about?" And he lifted up his shirt, and there was like a gun sticking there. We were like, "Oh, this is serious." And so, hand over all our money, and then, we got the hell out of there as fast as we could.

There was a guy that had befriended us, one of these minibus drivers. His name was Shine Head, that's what he called himself. So, we actually found him, and he's like, "Why are you guys so distraught, what happened?" We said, "We just got held up." And God bless him, he drove down to this beach without us, talked to all these guys and got about half of our money back.

How was your time in Spain, what did you do there?

Time in Spain was really good. I lived with a family, and they were pretty well to do, so, they had an apartment in Madrid. And then, they had a beach house in a town called Alicante, on the coast, in the south. And then, they had an old family home in a little tiny, tiny village called Guadamur, which is just south of Toledo, which is an old medieval town in Spain. And so, we spent a couple of weeks in Madrid, I was there for nine weeks, I think. And I just finished my sophomore year in high school. So, 16, I guess. And I had never done any traveling before that. So, this is a big departure. And it felt so foreign to me. I mean, the food, in particular, was so... and my Spanish was not terribly good.

I had taken Latin in seventh, eighth and ninth grade, and switched to Spanish... Oh, no, seventh and eighth grade, and switched to Spanish in ninth grade. And then, in 10th grade, took Spanish again, and then went on this exchange program. So, I lived with this family. And in Madrid, I just remember being really hot, and we played a lot of soccer. And then, on the beach, they had the whole month of August off. So, that was where we spent most time, we spent probably four or five weeks in this little town. And we would get up in the day and go down to the beach and lie in the sun and play in the water for 12 hours. And then, stay up till two or three in the morning, out on the beach, hanging out with people.

And then we went to this little tiny town, and they had a little farm there, where they grew figs. And we just toured the sites for a week or so, and then, I came home. But the homestay experience was, I found it really challenging. I felt homesick, I felt really uncomfortable. I felt really foreign, I felt stressed out. Because, I didn't want to do something that was offensive to them, and there was a communication barrier. So, it was a big growing experience, and most of it was fun. But there were parts of it that felt pretty intimidating.

What's the best business you've ever seen?

Two answers to that, with the initial caveat that there's lots of businesses that I love, because as I mentioned before, I'm a business junkie. But, because we're in Oregon, there was a business, I'll give an Oregon business story. There is a business in Oregon called Random Lengths, that is a price reporter for dimensional lumber throughout North America. So, dimensional lumber is like what you'd go and find and buy at a lumber yard. A two by four, that's eight feet long, or a two by six, that's 12 feet long, that's dimensional lumber. And it gets traded actively, there's a very active trading market for lumber and other building materials. But, Random Lengths was started a couple generations ago. I think, it just sold finally. And now, it's no longer under the same family's ownership.

But, they became the price reporter. So, sort of like the Dow Jones for dimensional lumber pricing. And people started to refer to pricing of lumber as Random Lengths' plus or minus. Because, every week, they would come out and say, "Here's the price of all these lumber categories." And so, it effectively had a monopoly. And it became one of these iconic, almost like a Kleenex or a Jell-O, right? When you talk about lumber pricing, you talk about Random Lengths. And so, just from a pure economic standpoint, and dominance as an entry, it's not a large company. But, the impact that it had on a very large industry was tremendous. So, that's my Oregon business story.

And then, my other favorite business, partly based out of just personal interest, I love being outdoors and spending time in the wilderness, it would be Patagonia. That's a business that I wish I had started. It's a business that I think has built an iconic brand, that has exceptionally high quality products, that has endured for decades now, that has a positive impact on, not only the environment, but I think on business. Some of a lot of things that they've done in retailing and in clothing manufacturing around sustainability and recycling of products has been groundbreaking, and I think have caused other players to follow suit. And it just seems like it would have been a tremendously good time to have been the founder of that company.

Thank you for joining me this morning, I loved our conversation. Looking forward to another one soon.

Yeah, likewise. Thank you for having me. This is a lot of fun.