Dr. Newton Campos crash Course on Entrepreneurship through Acquisition - Understanding Search Funds

Foreign Hello. Welcome to our crash course on entrepreneurship through acquisition. My name is Newton Campos. I'm a professor of entrepreneurship and innovation and also professor on risk capital, private equity, venture capital, and of course search funds. And I'm here with you today to explain you a little bit more about this asset class. This is an asset class that is growing all over the world. I'm very excited about it and I'm here to explain you a little bit more about it. Well, I took some notes here. I'll share with you and I'll follow this guide for you, this script for you to follow me. Basically, I divided our content here today in four big steps or four big topics. Let's say the first one is understanding, so understanding search funds. And just for you to understand, although in the academia we call it entrepreneurship through acquisition, that's the, let's say formal term over which we call this practice informally around the world, mainly by investors we call also search funds. You understand why? In a minute. But anyway, so the first step is understanding search fund. We'll go through that and then after a while, in a couple of minutes we'll get to, you know, preparing for search. How do you prepare for search? Preparing for search. Finally, our third step here will be about acquiring a business. Acquiring a business. And finally fourth step will be about growing the business you acquired. Okay, let's go through each one of those steps and see how it works before going into each one of those topics. Why should you care about entrepreneurship through acquisition in the first place? Many scholars today believe that we are living in a life of private equitization of capitalism. Wow. I know it sounds a bit too theoretical, but what that means is that, you know, more and more, all over the world, we are more able to acquire pieces of companies that are not traded on stock exchange. Basically, these are companies that are either small or medium sized companies all over the world that we are more and more able to acquire a piece of it. You can buy 10%, 30%, 60% or even 100%. And that's where search funds lean upon. You know, search fund as an asset class, as we'll see now in the first step, in the first part of our course is an asset class just like any other kind of investment. And it's a cousin, I would say, of private equity. So let's understand a little bit more about what private equity is and how search fund is similar or different from private equity. So what is a surge fund? Let's take a look. Look. Usually you can see all kinds of investments in terms of the degree of risk that you're taking. And of course, the return, usually the higher the risk, the higher the return, right? So in alternative investments in which search funds are included in, you have other kinds of investments like venture capital or private equity. These are two cousins of surge funds. Surge funds are more or less in between them. So in private equity you have lower risk and lower return. And in venture capital you have higher risk and higher return. Surge funds are very interesting as an asset class because search fund is a kind of private equity and the risk return is higher than private equity, but the risk is similar to private equity. So we could put private equity here, search fund here, and venture capital here, which makes Search fund a very interesting and growing asset class all over the world today. So how similar is Search fund from venture capital and private equity? Remember, in both private equity and venture capital, what you're doing is acquiring a part of a company. In venture capital, you're acquiring usually, let's say 20% of a startup, right? And you're expecting the value of this startup to grow or skyrocket. And so you have 20% of it, and so you get your return over that. In private equity, you are usually acquiring more than 50% of the company, perhaps 70 or even 100. But this is a larger company, it's not like a startup anymore. This is a large company and you getting from 50 to 100% of it. And of course again, you will do the best you can to increase the value of this large company and then sell later the participation you have with some profit. In search fund, interestingly, you acquire companies, you as the entrepreneur, together with your investors, you acquire companies that are existing companies. They are not large companies. They are what we call SMEs. So companies that are small or medium enterprises where you acquire also with the objective to grow them. And so here you're acquiring a company that already have history, have customers, has partners, and so on and so forth. So here it's similar to private equity, but in a smaller scale. You, as a searcher and future CEO of the company that these investors acquired with, you will be the CEO and the entrepreneur of this newly acquired company to make its value to grow. So basically you have two types of search funds. We can actually find more types, but these are the main types. You have traditional search funds and you have self funded search funds. Here we're going to talk about traditional search funds. Traditional search funds usually work this way. You first raise, we'll see the details soon. But you first raise a capital here that is the search capital. Search capital. This is a capital that is approximately, okay, US$500,000 that you raised with investors for you to search search for a company to acquire, for you to manage. After you find this company, you raise another amount of capital, much bigger than that. Usually you raise from 5 to 20 million dollars to which we call acquisition capital. Acquisition capital much bigger than this, of course, but that's ready for you to acquire the company that you will become the CEO with the support of these investors here. Okay, so this is how a traditional search fund model works in the other side. The self funded model usually works this way. You don't raise this capital here, you, you by yourself search for a company. And once you find the company, you go after the investors. This is harder to do. Okay. Because precisely what adds value to the process of search fund is that you hear, you know a number of investors, you work with them for a couple of years usually, and then when you find a company to acquire, they already know you, you already know them, and everyone is happily working together for the next step, which is acquiring the company. So all we're going to explore here are traditional search fund, it means that you did raise fundraising for your search capital and then you finally raised capital for acquiring the company. Okay, well, we could divide the more or less the whole process of, of search funds and entrepreneurship through acquisition in more or less eight very clear steps. Let's start from the first one. The first one is exactly what you're doing now. It's considering. So considering is starting a search fund. So usually most people that succeed, you know, going through the whole process, usually they have an experience in family business. So they come from family business. Or either they have experience in a consulting company or they have experience in private equity and venture capital. And finally sometimes they have experience with M and A mergers and acquisitions. So they have experience in one of the very important aspect, I forgot to mention one, maybe they were business owners before or even owners of startups. So these are, you know, let's say five kinds of profiles that usually succeed. Well in search fund, if you're not one of those, there's no problem. There's no problem. These. I'm just saying that most of the people that go into and succeed in search funds come from these experience. Okay. Even though, you know, you might want to, perhaps what you want to do is precisely to go to work more and develop one of those experiences before you undergo a search fund process. So that's the first step. Let's go for the second one. And the second one basically usually is to take a top MBA. So most, most, again, searchers did a top MBA. Actually today we know that 85% more or less of, of all the searchers, they have a top mba. When I say a top mba, it's a good mba. Good MBA in North America, good MBA in Europe or in Latin America or in your country. But basically most of them have a top MBA, usually one of the top 20 or 30 best MBAs in the world. So this is usually another experience that these people have. So a third important step is to develop a ppm. A PPM in the language of search funds is like a business plan. Okay? We don't say business plan in search funds. We say PPM is a private place memorandum, which is more or less the same. It's a project that you develop telling what you're going to do to your investors. Finally, the next step is raise search capital. And as you remember, search capital is the money that you're going to use to search for the company you want to acquire. This money usually pays you a salary, pays you a team, a small team to help you to search for the company and also pay for something that is called due diligences. So we'll find out what due diligence are quite early in a minute. But basically these search capital will be used by you and your team to find, to locate the company you want to acquire. Okay? So you go to the next step, which is a very interesting step that is searching for the company. Usually this lasts from one to two years, sometimes a bit more, maybe three. But these are the period where, this is the period where you're searching for the company to acquire. Finally, you have another step, which is the due diligence that we just mentioned. In the due diligence, you are analyzing the businesses that you might want to acquire. You going through into the accounts, into the details, the products, the services, the market in which these companies operate so that you can have take a decision, you can start negotiating with the previous owners if you're going to acquire that company or not. And you start basically talking to your investors about acquiring that. If you acquire that business, then you go into the operating phase. Basically now you're the CEO, you're running the company, and this usually lasts from three to seven years. Okay? And finally, at the end of this process, we call it exit, is the period where either you're going to sell company or you're going to do something with the company where you can reimburse all the investors and yourself for this long trajectory that you went through. Okay, let's go to step number two, preparing for the search. And here is where you start to analyze. Where are you going to look for the company to acquire? Usually, first decision you have to take is the country. So where is the country that you're going to acquire? The company later is okay, in which region in that country, or maybe sometimes you're looking for in two or three countries, depending on the region of the world where you live the same within a big country. If you live a big country, you can define some states or some provinces where you think that you have a higher probability to succeed in acquiring a company. You also, at this stage will be defining what kind of industries you're going to look for Companies to acquire. These industries might or might not be compatible with the experiences that you had before, the professional experiences you had before. You, of course, have to combine industries that are growing. So you have to look for industries that are growing, but you also have to look for industries where you feel comfortable or you would feel motivated to be a CEO in that industry. And finally, you have to also consider the company. Which kind of company do you want to acquire? Well, when you look at the companies in search funds, they have to have a special, let's say, characteristic. You don't buy any company. A lot of people think that on search funds, you buy, let's say a distressed company. So a company that is not doing well. And then you, as a CEO and a manager, you're going to like, somehow reform that company and make it good again. That's exactly not what you do in search funds. That's very important. You do not do that. You do not do turnaround. Turnaround is a completely different business. It's not search fund at all. In search fund, you're looking for a good company, a company that is doing well, or at least relatively well before you arrived. So that will make your job much easier to perform. But, you know, some people ask, okay, but why would someone sell a company, sorry, that is doing well? Well, basically, there are a lot of people selling companies that are doing well for different reasons. Maybe they got tired of their business. Maybe they don't have succession, so they don't have people to succeed the companies that they created and many other reasons. So the main objective of a searcher is precisely to locate those companies and those companies important enough they are not doing badly. Okay? They are doing really well, or at least relatively well. Now, the third part of our course, now, you know you already did your PPM you already raised your search capital and you've been searching for companies. Now it's a time to start, you know, developing a bit more your search. We now in the phase of actually getting close to acquire a business. What are you doing now then specifically while you're searching for acquisition? Basically, what you're doing now is dealing with your pipeline, you know, your pipeline of potential companies to acquire. So you're talking to brokers who are selling companies. You're talking to also owners that are willing and considering to sell their companies to you. And you're talking to anyone who can give you a hint on what kind of business owners are willing to, you know, are considering to sell their businesses to you. So it is at this moment where you start to sign some letters of intent with some of those people that are, you know, considering selling their business to you. And you're undergoing through some due diligences, you are analyzing some of those businesses as if you were going to acquire. At the same time, you are talking to your investors and showing them every now and then, maybe every two or three or four months, how is your search and how are you arriving to date of acquisition? It is at this stage that you reach a very important milestone in your search process. This is raising the acquisition capital. Remember, now it's time you were spending that money to find the business. You came across a lot of opportunities, but now it's time to acquire the business. So how do you do? Now you go back to your investors, the investors that you contacted before, and you offer them the possibility, well, they have the right to acquire the company that you located in the same proportion of the participation that they have in the cap table of the search capital you raised initially. And so let's say if an investor acquired 10% of your search capital, he has or she has the 10% of, you know, the possibility of acquiring 10% of the company you located. Okay, now we are in the part four of our course and basically we're going to talk about growing a business. After all, it's all that was done so far was precisely to get to here. Now you become the CEO of the business, the president or, you know, the highest or the most powerful manager of that business. And now it's time for you to show your work. Now is the moment where you can prove yourself as an entrepreneur. Remember, entrepreneurs are different people in societies. Entrepreneurs are people who are able to implement innovations, who are able to implement innovative processes and basically make companies to be different, to be better, to be faster, higher quality, and et CETERA or cheaper than its competitors. And so now it's time for you and your team to show that this is possible. Remember, in search funds, usually, as we said before, you acquire a company that is doing relatively well. So in the beginning, you don't want to change much. You want to learn. Remember, the beginning of your mandate is to learn as much and as fast as you can about the business you acquired. So now is the moment where you go and you have a coffee with all your collaborators, you have a coffee with all your customers, with all your suppliers, all your stakeholders, basically, and you learn a lot from, and a lot about the business you're in, about the sector you're in, about your competitors, about, you know, the possibilities of growing in that industry and so on and so forth. This usually takes about one year. So you better be concentrated and focused during that one year without your eyes open so that you can learn as much as you can. And at the end of this one year, propose with a very, you know, elaborated strategy to your investors and to your board on what to do next with that company. Of course, after one year learning so much, you'll be able to bring some very valuable insights to the board and you'll be able to explore both, you know, opportunities and also challenges that you face ahead of the company you acquired. There are other things as well that you can do to become a good and successful CEO and an entrepreneur. One of the things that you can do basically is to have a better accounting, better controls in the company that you acquired. This is very important because this is what going to allow you to grow. You need data, you need information to grow the company you acquired. And so these are very important. You also will need technology. Technology, you also need technology. Technology will not only allow you to have better systems and better controls and better data, but it will also allow you to grow other areas of the company you acquired, like sales, like production and etc. So technology is a very another important drive for you to grow the company you acquired. So you have control, you have technology, and you have something that is very, very important each and every, every day, more and more esg. You usually acquire a company when you acquire an SME, a small medium enterprise. Usually these companies these days still do not have a strong practice on esg. Remember, ESG is environmental, environmental, social and governance. Which means that the companies that have a strong practice in ESG basically are companies that are responsible. And you want to be a responsible CEO, don't you? So, and societies want to work with responsible companies. So this is another challenge that is growing. And I, you know, I can be sure that most of the searchers that I come across these days, they are concerned with this topic and they are willing to implement ESG practices in the companies they acquire. Why is that? Because imagine in an industry, especially in an industry that is full of SMEs, you have many players and the probability that some of them have good practice in ESG is low. If you manage to make one company to stand out in ESG terms, probably you make this company to value more than the others. Another point that you can't forget and can be very useful in terms of creating value in the company that you acquired is basically something called internationalization. So basically, you can evaluate possibilities to make your company more international, operating with other countries, other regions, and basically expanding your business through other regions of the world. So if you consider all the possibilities, you have plenty of options to grow the business you acquired. For finally, you reach a point where you know all that you wanted to do with that company, or at least a lot of the things that you wanted to do with that company that you acquired. You did. You acquired a company at, you know, a price is X and you are now handling, you're now managing a company that worth what, maybe 5x, maybe 10x, maybe 20x or even more. We have amazing successful cases of entrepreneurship through acquisition where a company sometimes, or entrepreneurs sometimes can multiply the value of the company by many, many, many times the value of the original price that was paid by the company. So this is what we call the exit moment. The exit moment is when the value of the company is approaching a value, so the price of the company is approaching a value where all the investors, or most of the investors, including you, are satisfied with the return, with the return of all that work. So that's a moment where you have to evaluate what to do. You might sell the company to a strategic player, you might sell the company to a competitor, you might sell the company to a private equity fund, or even you, you might yourself acquire the company you acquired previously, acquiring the rest or at least part of the equity that you don't hold yet. So there are plenty of possibilities here, but now is the moment of exiting and basically concluding your managerial experience at that business. Finally, we reached the end of our crash course on entrepreneurship through acquisition. I'm very glad that you made it up to here and I would like just to share with you this passion that I developed. I love to help entrepreneurs. I love to help companies that are looking for successors to you. Know, take the companies to the next step. I love to work with investors that are willing to sponsor all of that. And I basically love the possibility of making responsible entrepreneurs, running responsible companies for a better country, for a better planet, for a better, you know, life in society. So I'm very passionate about the potential that entrepreneurship through acquisition has to make that happen. And that's the reason why I'm, you know, making this course. I would like to invite you, if you want to know more about that, I would like to invite you to click down below and know the course that I designed that is, you know, much more elaborate than this quick course that we went through here. And I hope, you know, you can enjoy more about entrepreneurship and the possibilities that entrepreneurship open up for you and for the people that you like.