Royce Yudkoff
Appearances
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
is that it's become much more of a venture capital play than a private equity play in the sense that I think about the way VC portfolios work. You guys are smarter and know more about this than I do. But I think the way VC portfolios work is you have 10 firms in a fund and you want one of them to win and maybe another one to break even.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
And if you end up losing all your capital in the other eight, it's not the way you wanted it, but you're still going to have pretty good results. And private equity is very different from that.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
Of those 10 firms in the portfolio, there may be one that has some loss of capital, usually not 100%, but some loss of capital, four or five that might break even, a couple that do okay, and maybe a couple that do very well, but not astronomically well. Is that fair, Royce? Yeah, I think that's fair, Rick.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
Unfunded search is very much like private equity, maybe even on the safer side than private equity. Funded search really starting to feel like VC investing to me. And interestingly, Patrick, one of the things that's changed a lot since we talked 10 years ago is much of the funded search is occurring through institutional investors. but rather small private equity funds that specialize in search.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
And they're increasingly dominating funded search. And that's a huge change. So they're looking at a portfolio level, much like a venture capital fund looks at it as a portfolio level. So it's very different.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
If you're an investor who's thinking about investing in one or two of these, either invest at the portfolio level in one of these funded search portfolios or an unfunded searcher who you know and love, somebody you know well, but not buying a portfolio of these is potentially a scary investment.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
And this is an odd thing. This market is so illiquid. It's really hard to find buyers. good companies to buy with recurring, what Royce and I think about as value investor plays, recurring revenues, enduringly profitable companies. There's so much harder to find and transfer than you would imagine that I think that's the bottleneck.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
I think there are searchers, there's kind of a market equilibrium going on here. There are searchers, there are investors, sellers, there's a whole bunch of information costs everywhere because it's a very fragmented market. And I think that keeps it down. What's interesting, fascinating to me as an economist and as an investor is that at least on the low end, multiples have not been driven up.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
If you want to buy a firm with $750,000 of EBITDA, that's a pretty good recurring revenue business without a lot of customer concentration. You can still do that for Forex. Probably can't buy a $2 million, a million and a half dollar EBITDA business. Maybe you could have done that 10 years ago. Can't buy that at Forex anymore.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
But you can certainly buy the sub-million high-quality business at Forex.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
Rick, are there others you'd want to put on this list? Well, I think you need to buy a business that you can manage. I like to say if you're allergic to fur, don't buy a pet shop. And I mean that to be emblematic of a whole bunch of things. So many businesses I could not run. I could probably run a landscaping business, but I don't think I could run a biotech.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
So I think you have to have a business that you can use your talents or develop talents to run. You don't have to know the business. You don't have to be an expert in whatever the business does, but you have to be the kind of person who could learn that.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
Right. Who ends up buying the blue collar businesses from our students? It's usually the people who are captains and lieutenants in the army and the Marine Corps. They're used to managing blue collar workforces.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
They say, well, we're running the company, but they have a different sense of what a company means. Anyway, so I would add that. You have to be able to run it. The other thing that's increasingly interesting, I don't know if this is a millennial thing or not, because I certainly cared about this when I was looking for a job, is people care deeply about where they want to live.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
I think Royce and I are not convinced, me maybe less than Royce, that you can run businesses purely remotely. I think just being there, walking through the shop floor, talking to people at the water cooler, I think all that belly-to-belly management, if you will, is just really essential, especially if you're inexperienced and young and learning the business at the same time.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
The idea that you can buy a business in Mississippi and run it from your ski lodge in Colorado just seems incredible to me. Although I wish it were true, I don't believe it's true. And so often our students are worried about where the business is. So they're worried about the quality of the business. They're also worried about where the business is.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
And then does the business meet their criteria as in what they could personally manage? So it's complicated. It's fascinating. We have this project where our students look at companies that have been for sale in recent past or are currently for sale as part of their project in our second year courses. And that's ongoing now. We recently had this day, Roy, tell them about that.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
Right. And you'd think that it would be like one great company and everybody would say, oh, that's the company I want to buy. No, that's not what happens. Beauty is in the eye of the beholder. Yeah.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
I mean, first of all, you need to have capital to begin with, the academic problem. But I think it's a pretty open market. And the reason I think that is our school, our institution, Harvard sensibly has very strict rules about relationships between faculty and students, particularly while they're students.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
So we can't even implicitly acknowledge that we're interested in investing in a student, no matter how much we like them or how much we like their business plans or how sure we are for success. And we always tell them the same thing, which is we're not allowed to even have a conversation with you. But if you're interested, reach out in May. after graduation.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
And what we find is that there's every year a few students who like us enough to wait till May to see if we're interested, but a lot of students get funded. If they're looking for search funding, they're doing it before that. And if they're unfunded, well, they don't need funding. And then when they come time to fund, they usually give us a call and
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
What we discover is often they don't need much equity capital and they're able to get it either from section mates or family friends or former employers. And there's an advantage of having smart money, but there's an advantage of having less smart money. These investment opportunities are not just dribbling off the trees.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
Yeah, I would say I agree with every word you've just said. I run into unfunded searchers everywhere. I coach little kids ski racing up in Mad River Glen, really small mountain relative to corporate skiing these days. And the other day I was having lunch and realized that there are three people that I could throw French fries at
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
that were searching for businesses at some stage of concluding self-funded searches. And there's a little place in Vermont. What are all these people doing there? It's just everywhere. So it's become mainstream. And I think the reason it's become mainstream as a career path is you can build the life you want to live, earn a great living,
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
And you can have independence in a way that you just don't get from a boss. And there maybe was a time when working for a big corporation had this safety to it. But I think that's pretty much gone. I think people recognize that you can work for your big company for 25 years and they can eliminate your division or send it to South America, Asia or whatever. And you're going to be out of a job.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
We like to distinguish between the risks you can see and the risks you can't. And when you're running your own business, you can see those risks. When you're working for a big company, you can't see those risks. They just happen to you.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
That's a really interesting question. I think if you go back to the world before COVID, you've heard of COVID. The world before COVID, I think, proceeded somewhat orderly in an orderly fashion, as much as the world ever proceeds in an orderly fashion. And I think lots of baby boomers who own businesses got to the position where they said, wow, COVID's been really bad for my business.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
COVID's been really great for my business. COVID's really disrupted my business. I need to wait and see what's going to happen. And for the businesses that did really poorly, some of them bounced back. For the businesses that did really well, some of them have bounced down. And so they're still juggling. They're still looking for steady state.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
And so if you think about when you go to buy a business, you want to look at four years or five years of prior cash flows, that's going to include COVID still. So there's enough movement in results, just COVID-induced movement in results that I feel like there's been a lot of sellers who are just treading water. I'm going to wait till next year. I'm going to wait till next year.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
I'm going to wait till next year. And then one of the sad things about waiting for next year is that things don't stop happening. You've got tariffs, you've got inflation, you've got all kinds of crazy things that happen in the marketplace that while small firms are probably less impacted than the big public firms, it does boil down.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
And so I think there are lots of sellers who are waiting and waiting for times to settle down. And of course, I don't know. Do things ever settle down? I don't know. I don't know. So I think there are a bunch of sellers who are now reaching the end of their patience and health and are going to become more interested in selling as time goes on. So I think what you're going to see is...
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
Luckily, we'll never know if these predictions are true. I don't think the Patriots are going to win the Super Bowl next year. I do think the Celtics will win the NBA championship. And I do believe that there'll be some surge over the next three or four years of pent-up selling, and then it will go back to some steady state level.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
So there are certainly people who buy software businesses. What we find, though, is they tend to buy niche software businesses. They're software for podiatrists. They're software for small municipalities. They're things which you're unlikely to get big disruption and unlikely to have these cataclysmic shifts in. So it's software where the underlying market is fairly steady.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
What we don't find, at least if we find it, we throw it away really quickly, is people investing in very fatty software, the latest computer app or social media, whatever it is. So there's less of that, but there are, if you will, the business of established software, improving it, growing it, maybe migrating it to the web, but that the market is nichey.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
That seems to be a pretty sustainable investment thesis.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
And sometimes what they're doing is bringing management talent and skill to a segment that didn't have that management talent and skill. We just did a podcast with one of our former students, Logan Leslie, and he's doing a roll-up of auto repair facilities.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
And what was fascinating is that it used to be what would happen is you can imagine, think about an eight to 10 bay automotive repair facility. The way this gets started is somebody starts repairing vehicles and the person is probably a pretty good mechanic. And pretty good at repairing things.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
And now as he gets bigger, assuming it's a man, as the place gets bigger, suddenly you're now hiring and ordering and doing accounting and doing a whole bunch of back office stuff. And then as you get to a certain size, the founder is no longer pulling wrenches and changing water pumps. All they're doing is management activity. And you know what?
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
They might be fabulous mechanics, but it's unlikely they're both a fabulous mechanic and a great manager. And what Logan has done is said, let's let the fabulous mechanics be mechanics, And we're just going to take the management piece and do that centrally. And it has been a fabulous success and really clever.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
And as Roy says, it is application of the same idea, whether it's veterinary services, concierge medicine, or apparently automotive repair, or HVAC. What you're doing is allowing enough specialization for management talent to bloom.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
I always focus on the ability of getting the deal done because no company is very good if you can't actually get a transaction completed. And for me, the biggest red flag is multiple owners. If you have an owner in the 70s and another one in the 50s and the owner in the 70s has been working on the sale,
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
There's just an unbearable probability that when the person in their 50s finds out or understands what the transaction really means, they're not going to sign. And you can go months and spend money on QV and attorneys and write asset purchase agreements and feel like everything's gone. That's great because you're only communicating with the partner who wants to sell.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
Everything's gone real well until it just never closes. That's a great one. I hate that. Committed sellers are at least as hard to find as good companies. So you really, really need to pay attention. to why people are selling and whether they really are selling. And if you have more owners, you have more places where you can fall off. Here's another one.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
You need to have a meeting. I like to have them on Wednesdays. The reason I like to have them on Wednesdays is you get Monday and Tuesday to cram to get the stuff that you promised last Wednesday done.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
And so does the seller. And the Thursday and Friday, I actually do it in an orderly fashion. So I love Wednesday meetings, but you need to have a Wednesday meeting where you say, what's going on? Where are we at? You were going to do this. I needed that last week. The banker needs this. The lawyer needs that, whatever that is. So that's really helpful.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
The other thing, though, that's really, I think, important is, and this is so hard, what I'm about to say, is you want to pay a price first. that allows you some margin of safety for due diligence surprises. Because in a lot of small firms, Royce's example was the owner perhaps being a little bit nefarious. But sometimes the owners are not nefarious. They just don't really know.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
They think they have contracts and they don't really have contracts. They think they have what we would call contractually recurring revenue and they don't. They think they have all the documents. They think they have all the licenses. They think they've been paying all their sales tax.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
And as you dig in, a lot of those things, the broker talks to the owner, the broker writes down what the owner says, puts it in fancy language with some pictures and produces a sim. You bid on that SIM.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
If you bid a full price based on that SIM and then discover maybe revenue quality isn't as high or they've been underinsured and you have to have some higher insurance or that employees haven't had raises in five years or there's a bunch of accrued bonus that needs to be paid. If you've paid a full price, then your only choice is to go back and say, we need to readjust this price.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
Sellers, when they sign their LOI, think about how they're going to spend every penny of that price. They've purchased their vacation homes. They've designed their boats. They've planned their trip around the world. And they've spent every penny of that $2 million or $5 million that you want to spend, that you plan to buy. And when you say, well, it ain't going to be five anymore.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
It has to be four. They're going to go kooky. It becomes irrational at that moment. And those deals tend to bust. So I would say you want to give yourself enough room so that you can absorb some due diligence disappointments. But having said that, the LOI process is competitive and brokers want every penny they can get.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
And sure, they care about whether you have funds and what's the likelihood of closing. But since most buyers are one-time buyers, they don't have a track record of saying, well, we're not the highest price, but you should take our bid because we always close.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
As part of the transition into ownership of the business, they go talk to their customers and they discover that there are services and extensions that their customers are so eager to get. And the seller might have said, well, that's a lot of work. I don't want to do that. These young whippersnappers, they got a lot of energy. They say, oh yeah, we can do that. We can do that.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
And they're able to grow because their customers actually want what they provide. I think the small firm space is capitalism done well. You find entrepreneurs working on their businesses so that their businesses delight the customers. The customers are thrilled to pay for the services or goods they're getting. Nothing succeeds like success.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
If you have a vendor that's doing really good stuff and never disappoints, delivers on time and high quality, and when something goes wrong, they make it right instantly, and the owner gives you their cell phone number. boy, those businesses are going to grow.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
That's a new question for us, Royce.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
I'm going to do the rare thing of disagreeing with you. We teach a lot of theory, but we teach it in the context of practice. So we're teaching a lot about how to think about business, how to think about management, how to think about corporate finance. But we're always doing it in the context of a concrete, meaningful example. So it's not that we're not teaching theory.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
It's we're teaching theory in a more digestible form, perhaps, than equations on the blackboard. There's one case we teach that just always amazes me. Every time we teach it, I look at the teaching plan and say, this just can't work. And we go ahead and teach it. And it's like, wow. And students come back and say, wow, I learned so much today. And it's an amazing case. What is it?
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
I'll leave the protagonist out because it's an unfortunate situation. The former students buy a business, things go badly, demand falls. It just so happens to be the moment of the Great Recession. They're aware of the Great Recession, but they hadn't thought it through in their particular business. And so demand falls, they have a sticky product and they decide to cut price 10%.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
And we asked students, what is the implication of cutting price 10% to profitability? What is remarkable is after a year and a few months of business school, our students are mesmerized by this question. It never occurs to them that, well, let me see if my cost of goods sold is unchanged and my SG&A is unchanged, but I cut price 10%. wow, all that money is just coming out of profits.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
And my profit margin was whatever it is. And so, boy, I've just taken out my entire profit margin. And then Royce will go on and say, and if you're 70% debt, what does that do to the equity holders? And they say, wow, I've just destroyed all the equity value with this one decision. Now, there's a lot of theory in that discussion, but it's an interesting example.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
So some other things that I think have really been helpful. First, Royce and I have a fabulous partnership. We really enjoy working together. Interestingly, our students think Think about us as perfect substitutes for each other, where I'm the pointy-headed academic who got his PhD at 25 and hasn't really left academia, and Royce is the super successful consultant and private equity founder.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
And so we have very different backgrounds. We have a lot of mutual respect. And I think when our teaching works really well, We are bringing the best of both of our backgrounds to it. So that's really important. The other thing that's really important, I don't know how this will sound. I truly believe it. We really like our students. We have fabulous students. They're accomplished. They're clever.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
They're thoughtful. They're hardworking. They're serious. They're great. We can go years before we cold call a student and find them unprepared. It just doesn't happen. So we really respect and like our students. That is really helpful. We also think, at least I'm pretty sure I speak for Royce in this, We're really diehard capitalists.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
We really do believe that if you go out and you run a small business better, you're making the world a better place. We really believe that. And for us, we feel like it's not evangelism by any means, but we feel we're really helping the world and we're really helping our students. We're showing them a new career path and they're going on and doing wonderful things for their workers and communities.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
And it's super fulfilling for us. I've been at Harvard Business School for a long time, nearly 38 years now. Before I did this course, I taught everything in corporate finance, and I could go decades without somebody saying, you really changed my life. Thank you so much. You know, just teaching this kind of cash flow just doesn't evoke that kind of emotion in people. I don't know why. Doesn't me.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
But I don't know that we hear that every day, but we hear it quite often. And we see it in our students. And we see students coming back over and over again saying, your class was pivotal in my life. And we hear it in our podcast.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
I mean, the nature of small business is that they're generally undercapitalized and have to ration capital. And by the time they go to make capital investments, usually those decisions are pretty apparent. I have demand for another technician. That technician needs a new van. I'm going to buy a new van. There's a lot of that. One of the things we do talk a lot about, Royce, is IT investment.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
And we're generally negative on it.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
We generally say our students are of a generation that they can't get home without checking their phone about how to drive there. It hadn't occurred to them that they could just go the same way they went yesterday. They can't just go to a restaurant. They need to do whatever they do on their phone before they go. Anyway, it's a generational thing.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
But what we think is that many of our students want to go in a business, particularly if it's being sold by somebody who's in their 60s or 70s. It's probably technologically light. And our students always have this great desire to spend a couple hundred thousand dollars on a CRM. And we have two answers to that. One is a couple hundred thousand dollars is a lot of your free cash flow.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
You got to be thoughtful about that. Certainly your early years, if you're SBA, you don't have debt covenants, but a lot of them are conventionally financed and they do have covenants and they need to be mindful of those. So one is it's pretty expensive. And two, you don't really know what the business should be like in your first year. You got to really wait.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
And so if the old owner managed it by sticky notes, buy some sticky notes, go to Staples. They're not very expensive. You could buy a lot of sticky notes for a new Salesforce application. Yeah. Try that for a year and see what you really need. Because you'll be a better manager at the end of year one and you'll know exactly what you need then. That's a part of this.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
That is one form of capital investment. By the way, our students routinely ignore our advice on this, but we feel good giving it.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
It's not pole vaulting. I always wonder how people actually do the first pole vaulting. How do they do that? Or a ski jump. Put somebody on this thing that's tall, the Empire State Building. Just don't turn. Go straight.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
It'll be okay. I don't know how that actually works. Here's a stick. Stick it in the ground when you get close.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
When you land, it'll be fine. I don't know how that happens. This is a mystery to me. But searching is not. You just commit to it. There's this thing, Google, you can find brokers, you talk to brokers, get on their lists, you do some search, you look at some databases, you try to find what companies are out there. It's like so many things in life. Just do it.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
Just decide you're going to do it and then just... do it. Royce and I describe it step by step in our book. I think those steps can still be followed. But it is the case that most people discover that it's a highly personal activity, that they're going to do a geographic search that's a small geography.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
They're going to go move to that geography and they're going to go to every chamber of commerce event they can find. They're never going to have breakfast or lunch by themselves. They're going to meet people, meet people, meet people and find the business. They're going to go door to door if they need to, but they're going to meet every business owner in the locale.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
If people are doing a national search, it's a very different process, but again, it's heavily brokered or maybe it's direct outreach in an industry. But what I think doesn't work is theorizing what industry might be exciting in the future and spending six months theorizing about an industry before you actually call.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
So when we work with new searchers, we say, your goal for this week is to have an owner's meeting. Just have a telephone conversation with an owner. Just do that. That leads to something.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
Do you want me to take a crack at that, Royce? Yeah, you go first. I'll lob in some if I have it.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
Okay. So when we talked in 2016, nearly a decade ago, as you say, first of all, I had hair. So that was a big difference. You look great. Thank you. But aside from that, one of the things that has really changed is that the small firm space, the small firm acquisition space is really bifurcated.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
I wanna just think a little bit more about your example because everything you said made perfect sense, but that's not the way the empirics look. What looks is that people buy their businesses and then they all project five or 10% growth in their conservative case their first year, and they all have five or 10% losses their first year. It's 5% worse than their base case year.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
Some of that's because sellers sell on good years. And so this averaging central limit kind of thing But it's also learning the business and meeting customers and distraction and the seller's distraction and the business has some degradation during the sale process. All those things happen. But I think the idea is that what you said is right. The first two are about getting to the transaction.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
That is getting the transaction. Talking to the customers happens often during that first year, but you're not able to capitalize, make good on those ideas, usually for a year or two. So what we see is year three, the really good year.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
Yeah, I think it's diversification. Diversification issue. Thank you. As another way of putting words in Royce's mouth, some investors are willing to recapitalize and re-incent the CEOs. It's a cumbersome thing because you don't really know what the value of the business is. It's really hard. And a lot of it depends on the business.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
With the funded searchers really moving up market into much larger deals, the averages keep moving around, but think $20 million of average total enterprise value.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
CEOs, because they're so focused on their business and have such a concentrated position in their portfolio, they may have a key contract, three-year contract, and they won each of the last three years, but they get convinced that the next one they won't be able to win. And I don't think it's because the facts on the ground have really changed that much.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
I think it's that they look and say, oh my word, if I don't get that contract, it's to my personal wealth and I don't want to be at that risk. So I think as you have more to lose because you've accumulated wealth and you have an illiquid, undiversified position, I think that tends to drive people to sell.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
Whether they sell too early or not, I don't know, because I think from an investor standpoint, they might be selling too early. From an entrepreneur standpoint, they might be selling at just the right time because they're living with this really high cost of capital because they're bearing all this total risk, not just the diversifiable risk.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
And the unfunded or self-funded or spouse-funded or family-funded, whatever you want to call it, where they don't take investor money at the time they begin their search, so unfunded for me, those unfunded deals have actually gotten a little smaller. So people have discovered that there are great opportunities buying below a million dollars of EBITDA, thinking about, well, what if SDE is $600,000?
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
Well, that's a hard question. And I think I'm not the best person to answer that because I'm really limited by my experience because I'm not a very techie guy. I mean, I can log into my computer and I got a new phone. I don't even know how to shut it off. So I don't know. I'm not a person who really thinks deeply about how AI is going to change our educational experience.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
But what I can say is I taught at MIT before I came to Harvard. And at MIT, we taught things. At Harvard, we really teach situations. And what I find our students are extraordinarily good at is pattern recognition. It's hard to see how this learning happens. It's hard to measure it day by day. It's hard to quiz them on it.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
But what is absolutely true is after two years of a case-based education, you've seen hundreds and hundreds of situations and life is going to give you those situations. So I can't tell you the number of times I'll meet with an alumni and they'll say, we'll be talking about something and they'll say, oh, that's just a bottle of lumber.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
Now, it's not about lumber distribution in whenever that case was first written in the 1950s. That's not it. But it is the case of a company who's, in the case of bottled lumber, makes financial profits but no cash profits because all the cash goes into working capital. So there's that pattern recognition that just sticks with people.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
And I think it's really hard to Google your way to pattern recognition. It's like so many other things. There's no gizmo to teach you how to be a really good alpine skier. There's no piece of AI or science that's going to make you stronger in the weight room or faster on the track. I think you just have to do the work. As I like to say, success only comes before work in the dictionary.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
Can I get by? Can I grow this business? And we're finding more and more students buying smaller businesses at lower multiples, think three, four, and other students going in the opposite direction, buying much bigger companies at much higher multiples, think six, seven, eight. So it's really bifurcated in a way that I wouldn't have predicted 10 years ago.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
I think that is true in learning. I don't think there's an easy way to learn. I think there are fun ways to learn, but I think you actually have to put in effort to learn.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
One of the things that's special about the Harvard Business School is we understand we're a business school. We're not an economics department. We're not a behavioral science department. We are very much a business school. So while as faculty members, we spend more than half our time doing research, that research has to have a business focus for it to be valued by the institution.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
Now, what that business focus is can be almost anything. It can be some behavioral way or it can be some new way of managing a workforce. It can be a new way of managing a portfolio. It can be all kinds of things.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
But I used to like to apply the rule, and I don't know if the institution would still agree with this rule, but I do, which is if you're working on a research project at the Harvard Business School, you need to imagine that somebody would actually pay for the results of your work. Maybe not the cost of the research, but they should be willing to pay something for the results of your research.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
And if nobody cares enough to pay for your research, then maybe you should be doing it in the economics department or God forbid, the Kennedy School, but not here.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
I mean, we certainly get questions about specifics in the small firm space. I'm considering this deal. The seller wanted to do this. Does that make sense? Does this equity rollover make sense? Does this structure make sense? I'm having problem with somebody on my board. How would you approach that? So we certainly get those practical business questions. I think we get questions.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
People call us often when they're struggling with something. Something just isn't clear to them and they want to go back and have somebody to talk to that they think is smart or clever or nonjudgmental or something. So we get a lot of those phone calls, I think.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
I was going to say, and often they call me when they have this sense that they might be wrong. Because you always say, Rick, feedback is a gift. I say feedback is a gift. And I'm willing to say to somebody, that's really stupid.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
I think that's correct because you're always more cheerful after this. I'm like, what happened to these students? Why do they want to buy such a crappy business? And you're like, oh, I talked to so-and-so.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
They have such a great deal.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
It's 80% recurring revenue. And I said, I don't get those.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
They call me with a pizza joint.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
That is a great case. And it's nice to start off with one that we know is going to work out pretty well. It will usually do that as our very first case of the year. I was going to pick one that will probably make your teeth hurt. Can I pick two? Because they're very similar, actually. No rules here. One is a company called Capital Digital.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
And what I really, really like about Capital Digital, it was purchased by a student of ours, Nick Anderson. And as all good cases came, I was at another student's wedding and happened to be sitting beside Nick. And I said, how are things going? And he said, I can't tell. And he described his first year of owning the business, which had its challenges.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
But what was hard for Nick was it was almost impossible to figure out what was really going on. And it just highlighted how special small business is. Small businesses are small and their information systems are small and the evolution of information is small. And so in this instance, there was nothing wrong with the business.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
But it sure looked like there were things that were wrong with the business. And it was just that the firm needed to worry about its product mix a little more carefully than it was. But it was very subtle. And it took them a few years to figure it out. But once they figured it out, they've been tremendously successful in the years since.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
But it's this evolution of information that I find fascinating. And my other favorite is a really odd choice, Royce. It is Brian Bonk and the Palfrey's case. So we close our course with this case. Every time when I'm getting ready to teach this case the night before, I say to myself, and sometimes I even call Royce, and I say, Royce, whose stupid idea was it to have this case as the last case?
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
Because this is just a terrible, terrible case. It's a story about a young man who gets his PhD in biology at MIT. And while he's in the process of getting his PhD in biology at MIT, he comes and takes our classes and decides there's a lot of smart biologists in the world, but there aren't a lot of smart biologists that own small businesses. So he's going to go buy a small business.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
Royce and I work with him and we really enjoy working with Brian. And he finds this business Can I say what it does, Royce? Is that okay? Yeah, absolutely. Finds this business that is in a most unusual marriage of businesses you can imagine. It is the largest rabbit slaughterhouse in the United States.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
And who doesn't want to own that and just be able to say to their grandchildren, I killed 5,000 bunnies this week. I have to be careful. My grandkids sometimes listen to this. And a biotech version that takes the byproducts of the rabbit meat and turns them into biological products that turn out to be essential into development. of so many things like Prevnar and a whole bunch of vaccines.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
So it is a really interesting business. Half really appeals to Brian, as you might imagine. Anyway, the last case is about Brian's attempt to close the business. I think it takes, I mean, we have the number of days in there, but it's like 280 days or something crazy like that. I mean, Moses got to the promised land more quickly than Brian gets to closing. And it's a video case.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
And the way we did the case was we had Brian record his impressions whenever he wanted to on his iPhone. And then the magic of editors pulled that all together into this video case, which is about an hour long. And you see this journey and it's like, well, I thought this issue was resolved. And Brian says, well, this issue's back. I thought it was resolved.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
This is the fourth time it's not been resolved. I don't know what to do. I'm just so frustrated. I guess I just have to get back to work. And it just is this, oh, my word. It so shows the frustration of search, the challenge of search, why it's hard, because information isn't always available at one time. Anyway, that's kind of a favorite of mine. It's a weird favorite, right, Royce?
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
The question I always have is why more people don't do it. We have 920 students graduate every year. Ought to be 100 people searching. We get like somewhere around 20, 25 a year. And then probably another 20 out of that class over the next three or four years. Right. Not 100 for sure. But not 100.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
And that doesn't mean there aren't great jobs in private equity and in corporations and in consulting. But for me, for my taste, this is such a better career path than working for somebody else.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
Not anymore.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
I agree with every word you said. I would also add one minor thing, and maybe this is my thought, and this may not be true. But I think if you somehow dug and peeled their hair away and dug inside their brains for a little bit, you would find that not everybody is comfortable with doing the most difficult thing that a CEO does, which is write down the to-do list.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
And it is so much easier to work for somebody and have them tell you what the to-do list is. I work for a private equity firm. They've told me to work on this deal or they told me to source in this industry. They're not telling me to pick any industry and source it and have my entire wealth tied to that industry. And even if I do do that, they're not telling me to run the firm after I bought it.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
There's a sense where you say, oh, when you're managing a small business or finding a small business, you're saying, this is important to me, this is important to our firm, and this is the direction we're going to take.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
And I think that's growing because people are saying, wow, I don't want to pay eight times to buy a $2 million EBITDA firm. So maybe what I'll do is pay three times and buy three and a half $600,000 EBITDA firms or something like that. And so they're buying low and sometimes the synergies and roll up potentials, but oftentimes they're just running three separate companies.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
But they're getting critical mass and they're getting some diversification and some drive and some opportunity to apply their talent. So it's pretty exciting. If I could add just one other thing, 10 years ago, this career path was viewed as quirky. To pick a word, Royce may have a better word, but quirky.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
We used to say jokingly to students that we would get calls from their parents and they would say, what did you do to my kid? I mean, my kid graduated from a really good undergraduate school, had... five years of really good work experience. And now they're sitting in their pajamas all day, staring at a computer screen with headphones on, sort of talking to themselves.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
Is this a depressive episode? Is this some sign of psychological break? Do we need to get our child, man or woman, do we need to get them therapy? Because it was such a quirky and unusual career path. Now it's become a much more traveled path.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
And our students can look back and whether they're men or women or veterans or English majors or engineers or private equity people in their former employment, they can always look back and say, wow, there are literally dozens of success stories that I can look back on. So it has now become a well-traveled path and a more acceptable path.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
For a searcher, there are two big risks. One big risk is failure to find. And the other big risk is buying a really terrible business. And the first risk is that you might spend two years of your life bouncing around from one thing or another and you just never get a deal done. It could be that you've had two signed LOIs.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
Both deals are broken and that happens probabilistically to some fraction of deals. The due diligence doesn't work out. The seller decides in the end they don't want to sell. The results turn out to take a nosedive during the due diligence process. And so there needs to be a price adjustment. So the deals fall apart. So I would say the failure to find risk is a real one.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
It's really interesting because there are different views on what this failure to find risk is just statistically. For the bigger funded searches, that number seems to be bigger than 50% suddenly, right, Royce? And that's really a change. It used to be hover around a third.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
But now, because people are buying bigger companies, as we talked about before, they're now competing head to head with strategics and private equity. And they don't always win those. They don't have the lowest cost of capital. So they have to be bringing something else in to win those battles. So those numbers are pretty high, the failure to find.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
I would just say on the unfunded searchers, if I could, the failure to find risk seems to be much, much smaller. So it seems to be less than 25%. Now, Royce and I like to think that it's because our students are just better educated. They're better searchers than the people from that other institution on the West Coast. Who knows? But they're looking for very different things.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
They're not looking for high growth. They're looking for boring businesses that have steady recurring cash flows, businesses that have sustainable profitability, enduring profitability is the term Royce and I use. So it's a very different business. You're not growing at 30%. So that's the one risk from the search or failure to find. And it depends on what you're looking for.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
On the getting stuck in a bad company thing, that may be the bigger risk. It actually doesn't happen very often to our experience. Now, certainly there have been deals where entrepreneurs have worked really hard and not made a lot of money in the deal. But generally, it's because the world has somehow changed, not because the business they bought was fundamentally bad.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
It's an oil service business that's purchased just as oil falls off a cliff. Generally speaking, though, I don't think people are buying bad businesses because I think it's hard to buy a bad business and get it through the due diligence process and get it financed both through the banks or... through equity holders.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
So I think investors provide a pretty good gatekeeper for getting stuck in a bad business. I can't say it never happens, but it doesn't happen as often as you might think. Now from investors, Royce.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
It's hard to get a zero.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
Unlike private equity, it's hard to find a great many instances, particularly in the unfunded market, where investors lose their capital. Just doesn't happen very often. I would say in the funded market, the other thing that I find interesting, and I'm not sure about this, this might not be true, but I have the impression.