Jeff Stevens & A.J. Wasserstein on The Future of Entrepreneurship Through Acquisition
Jan 18, 2024
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Jeff Stevens and A.J. Wasserstein, distinguished investors in the ETA ecosystem, discuss the future of entrepreneurship through acquisition. They cover the growth of the ETA community, software acquisitions, investor mindset, search fund growth, and motivations behind business sales. They emphasize the importance of prioritizing the searcher and personal growth within the search ecosystem.
Entrepreneurship through acquisition has seen significant growth due to formalized courses, availability of capital, and software as a target.
Software acquisitions have become popular due to recurring revenue and growth potential, but come with challenges and risks.
Investor support and partnership are crucial in the search fund ecosystem, with considerations for free rider problems and long-term success.
Deep dives
Growing Interest in Entrepreneurship Through Acquisition
There has been a significant increase in interest and participation in entrepreneurship through acquisition (ETA) over the last five years. This growth can be attributed to several factors, including the prevalence of formalized courses and clubs focused on ETA in top business schools, the availability of capital for talented entrepreneurs, and the attractiveness of software as a target for acquisition. The ETA community has evolved from a niche and unconventional asset class to a more recognized and institutionalized model. However, there are still challenges to navigate, such as the free rider problem and potential dilution of the core values and culture of the ecosystem.
The Future of Acquisition Entrepreneurship
Jeff Stevens and AJ Wasserstein, two respected investors in the acquisition entrepreneurship ecosystem, explore the future of entrepreneurship through acquisition in their paper. They discuss the changing landscape of ETA, the growth of the community, the increasing popularity of software as a target, and the evolving search fund economics. They highlight the importance of placing entrepreneurs at the center of the model and maintaining a commitment to partnership, while also acknowledging the challenges of scaling investment practices and ensuring strong investor support and bandwidth for searchers.
The Rise of Software in the Search Fund Ecosystem
Software acquisitions have gained significant traction in the search fund ecosystem. This is due to the appeal of software business models, such as recurring revenue and high operating leverage, access to growth markets, and potential interest from future buyers. However, there are considerations and potential risks associated with software deals. Valuations based on revenue multiples place high requirements on growth, which can be challenging for young and inexperienced CEOs. Operational complexity and the need for ebitda-neutral or ebitda-negative management also add complexity to software businesses. While there have been successful outcomes, the search ecosystem needs to carefully navigate the balance between software investments and the core principles of enduring profitability and prudent leverage that have traditionally driven successful deals.
Cap Table Composition and the Free Rider Problem
The composition of the cap table in search fund investments, particularly in relation to software acquisitions, has gained attention. The decision-making process for investors is influenced by the desire for strong support throughout the search process, ensuring a balance between investor commitments and operational bandwidth. There are concerns about potential free rider problems, where passive investors benefit from the insights and experience of more active investors. Searchers need to carefully evaluate investors and seek those who are committed to providing support. While there is a natural desire for validation from trusted peers, it is important for investors to consider the long-term success of the entrepreneur and the overall partnership within the ecosystem.
Search model aims to manage risk and navigate challenges
The search model, designed to manage the risk of inexperienced individuals entering unfamiliar industries, requires a buffer to address the potential hiccups in the first 12 to 24 months. However, it has been observed that businesses are increasingly being valued based on revenue multiples, including ARR multiples. This approach of slapping a revenue multiple on businesses with recurring revenue can be risky, as it assumes sustained growth and expansion. The lack of historical data on business valuations based on ARR multiples creates uncertainty, and there is a risk of multiple compression. Therefore, caution is advised when expecting expansion on an ARR multiple business.
Debating the terms in search fund economics
The terms offered to searchers within the traditional or funded search fund model have not changed significantly over time, leading to differing opinions on whether this is a good or bad thing. Supporters argue that these terms are well-established and strike a balance between risk and reward. However, detractors believe that the terms have failed to evolve and adapt to changing supply and demand dynamics. It is suggested that as more capital floods into the system, entrepreneurs may seek better terms in order to secure a higher share of the upside. This could lead to potential changes in the terms offered, which could impact the traditional search fund model.
Today I'm joined by two of the most thoughtful, distinguished, and respected investors in the ETA ecosystem, Jeff Stevens and A.J. Wasserstein, to discuss the future of acquisition entrepreneurship. The paper that inspired this episode, written by both Jeff & A.J., can be accessed here:
Jeff Stevens is the Founder of Anacapa Partners, a firm with over 20 years of experience structuring, operating and investing in search fund-owned companies. Jeff was an acquisition entrepreneur himself, having managed 3 funded searches during the period from 1990-2005, each one culminating in the acquisition of a SMB.
A.J. Wasserstein is the Eugene F. Williams, Jr. Lecturer in the Practice of Management at the Yale School of Management. His research, writing, and teaching concentrates on search funds, entrepreneurship, programmatic acquisitions, and small businesses. In addition to his role as an educator, A.J. is also a private investor in lower middle-market businesses.
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