Episode 2 - Ibrahim and Khaled Abdel Rahim of Moonbase Capital

Also very important, you have to have the humbleness to understand and to respect that there are people that have been in your business for much longer than you have. So it's not only about having the skills, it's not only about being very good at finance or being very good at some type of consulting business. You really need to have at core and in your values, the ability to lead family business.

So the big question is this. How are entrepreneurs who aren't scaling tech startups or building lifestyle businesses from scratch doing it? How do acquisition entrepreneurs find businesses by, in and then create generational wealth while taking on less risk? Welcome to this month's episode of Search Funded, the Entrepreneurship Through Acquisition podcast. Today we are joined by Khed and his brother Ibrahim Abdel Rahim, partner and Managing Director of Moonbase Capital, respectively, to talk about why search funds are a major private equity strategy for the coming years. Moonbase Capital invests in and provides hands on support to search funds in Spain, France and Italy. But before we get to that, maybe Ibrahim can start and tell me a little bit about his background and why he and Khaled decided to start Moonbase.

Thanks Nick. It's great to be on your podcast. So basically me and Khaled started off our careers in our family business, so we are SME people at heart. Our father was a founder of a company similar to the ones we invest in now. So I started off my career in the family business and then I turned into consulting back to the family business. So eventually I went to Stanford thinking that startups is the thing I want to pursue in my rest of my life. However, at Stanford is where I learned about search funds. I fell in love and then we went back to I went back to Europe to start investing in search funds along with Khaled who has been my partner in crime over the years.

Search funds are definitely a growing area and a lot of the top business schools like Stanford are where people hear about them. You two have recently completed a white paper on search fund versus private equity or venture capital. What would you say are the biggest risks and returns of search fund versus those two types of investment?

So the first thing I'd like to start with when it comes to search funds, the criteria is really what sets aside search funds from pe. When you look at pe, obviously that's the overarching asset class and then within pe, it's the criteria itself helps really find the balance between a low risk investment that can allow for a highly leveraged transaction. So at least in the classical way of search funds, leverage is a big part and is a big lever of the transaction. And the search fund criteria is a big part of the balance that allows you to have the possibility to have that leverage and at the same time not be a highly risky investment. You add to that all of the growth aspects and all of the certainty of revenue aspects inside the the criteria and then you have a very nice mixture, I'd like to say, of characteristics that really they set the investment ready to succeed.

Yeah, I mean, I'd echo that. If you compare such funds to any other asset class from a risk and return balance, I think it's the healthiest because you're talking about a asset class which is very low risk and at the same times return is really high compared to any other asset class. Actually, based on Stanford and ES's numbers, there is no other asset class over the past 30 years that has averaged at anywhere around 30% IRR. And doing that with companies that are quite sturdy and quite, I mean, According to say 1 out of every 10 investments go bad versus in VCs, which is the numbers, maybe 8 or 9 out of every 10 actually go bad.

So yeah, and I think it really makes sense because what really sets aside search funds and one of the things I really like about it is that when you look at the investment that what needs to be done to attain the expected IRRs that are sometimes the average out 30%, what is required is not very high. So you're not doing any turnarounds there. You're not buying distressed assets. You're not buying assets or companies that have thousands of employees you're buying. In most cases, businesses that are very simple, that have great track records, that are amazing in their own right. And all you need to do is find a way to maintain that momentum. In most cases, just by maintaining the momentum of that business, you can get very good IRRs which reach the 30%. You're not really required to do the same acrobatics that could be required of you if you were doing a startup. And all the stress of a startup, you don't have that type of stress.

Right. Yeah. I think that is why search funds are attractive for investors and also search fund entrepreneurs. One main difference of a search fund is that you're investing in an entrepreneur who's going to go find a business and then acquire it and take it over versus VC or pe, where it's a very different strategy either investing in startups or finding, as you mentioned, turnarounds or other larger businesses where you can add value. How does that Change the investment approach when you have to find an entrepreneur who goes to find a business and then acquire it and then run it versus those other strategies. How do you approach that and what skill sets are needed to be a search for an investor versus other forms of investors?

The beauty of the model is that you get acquainted with the entrepreneur over the two years where the entrepreneur is looking for a business to find and to buy. And during this time, we work very closely to the entrepreneurs. So you get to become quite close by the end. And this is a big difference if you Compare it to VCs, where you need to decide on the investment after a few meetings with the entrepreneur and his team. So that's one major difference versus VCs, which makes it very interesting. However, it's very hard to know which entrepreneur will get the best company. There's so much involved in finding the right company. So the best is to have a big pool of entrepreneurs that you work with closely and monitor closely. Monitor is the wrong word, actually. I'd say partner with and support closely. And then eventually you look at the companies and this is where the real decision is made. It's never at the entrepreneur level. It's more at the company level when you have the SME and it's even.

The marriage of the entrepreneur with that acquisition. Because in many cases we find amazing entrepreneurs that make perfect sense with their acquisition. It's like it's a true marriage. Their characteristics as entrepreneurs sometimes fit perfectly with the acquisition and that's when you have the best cases.

So what do you look for in these entrepreneurs? You mentioned that they can make a perfect marriage with the acquisition. So do you have an industry thesis and then you look for searches who would fit well in that industry? Or is it more the. The soft skills that you look for? What is the profile of the searcher that you look for? Is their industry thesis or their profile or anything else? And do you look at their PPMs, like, do their terms matter at all? Or what are the top things you look for in the searches that you decide to invest in?

Okay, so. So I think the first part is when you are selecting a searcher in the very beginning. So a searcher that is just starting out and you're interviewing them. I think for us we have obviously a large criteria, but we look for someone that is very well balanced because you cannot have someone that is highly technical but does not have the ability to lead and to accommodate a standing group of people that have been operating this business for 30 years. Because this is also very Important. You have to have the humbleness to understand and to respect that there are people that have been in your business, in that business for much longer than you have. That, I think is very, very important. You need to have the characteristics that the actual personality traits that really allow you to have the ability to really lead a company that has had an owner for so long. And at the same time, you need to have the values that would steer it forward and you need to have the expertise and the skills. So it's not only about having the skills, it's not only about learning, being very good at finance or being very good at some type of consulting business. You really need to have at core and in your values, the ability to lead a business that has been used to being led by a usually their family businesses. So you really need to be able to take the lead on these matters. So I guess the short answer is you need to really be. It's a balance basically of a bunch of things that revolve around leadership.

Definitely, yeah. And at Moonbase you have a bit of a different model from a typical search fund investor with your advisory board, which I'm sure helps the entrepreneurs grow towards where they need to be a lot as well. Maybe you could talk a little bit more about that and how you differ from other search fund investors and what you're building at Moonbase.

So we believe in the partnership between the entrepreneur and the investor. We believe that the entrepreneur requires a lot of support in order to mature over the two years and become able to lead a company and find a good company and do the due diligence. And all this requires an investor that's involved. So we at Moonbase very much work closely to our entrepreneurs as much as we can and we get in a bunch of advisors who are very wide in terms of expertise in order to support them. They depending on the needle entrepreneur. So for example, if you have a entrepreneur looking at a company in automotive, we have some advisors who know automotive or if you look at someone who wants to scale a business fast, we have people who know sales and yeah, we have around 40 advisors. And the way we work is by linking our advisors and our own expertise very closely with the entrepreneur itself. And we think that's the way that investors should do. Investors should be close and should be offer more than money in a search fund situation.

Yeah, makes a lot of sense. I think this is something we've seen in the startup world and it's interesting to see it move over to search fund because I think there's a Lot more added value that can.

And I think I, I really would like to, to underscore that. I think the beauty of search funds, I think it takes a lot of the beauty of vc, all the good aspects, the entrepreneur, the support of the shareholders and that are seen with vc and it takes that into pe. So I really think it's really, it's.

A healthy mixture between both, I would say. I mean, the way I say it sometimes is you do a private equity job using a venture capital methodology, basically.

Great way to put it. So talking about PE and vc, these are industries that have really been supercharged by low interest rates over the past decade or so. And now that we have coming recession, inflation, rising interest rates, how does that affect research fund? Is that an opportunity or is there more challenges now? What are the macroeconomic factors that are happening now and how do they impact search funds, if at all?

Okay, so I think basically you have the search fund criteria, and the search fund criteria really shields you from a lot of the potential risks of a recession and inflation you add to that. So for example, in Moonbase we have also we add to the normal search fund criteria, we have our house criteria. So we have internally, for every, for every period, you have your own set of house criteria which you like to add. So for our sense, what we do now is we try to make sure that we avoid anything that has an impact, for example, that could be impacted by luxury items. So if you have a client or if you have an acquisition that could be affected by a decrease in disposable income, for example, it's a supplier of a material that goes into a luxury good. Those types of businesses we tend to now make sure, tend to test and try to avoid, because we could find, especially in recessionary environments, disposable income levels could start to waver. Also, for example, we look at transferability of costs. So when, when you have an inflationary environment and when we expect costs to rise, we try to make sure that the acquisitions, the businesses we are acquiring, have the ability to pass on these cost increases to their clients. And definitely these two things really, in most cases we find that our acquisitions are there already. But you just need to make sure that in addition to all of the measures that exist in the criteria, like recurring revenue, high margins, which cushion a lot, you have low capex requirements, you have a fragmented customer base. All of these help shield these types of situations. The risks involved from interest rate growth or from potential recessionary environments.

I mean, at the heart of the search fund model, the type of Companies that we see probably most successful are the ones that have a product that is quite important to the clients, but is not the core of what they do. So it is, for example, a company that does a service which is very important. However, it's not the core, so it's not a big part of the cost. So you could easily push some of the costs that come with inflation to your clients simply because you increasing the price of your product does not necessarily create.

Affect their cost base. So it's not your. Your product is not a big part of their cost structure, their entire cost base. So that allows you to have more leeway when you would like to pass on your higher costs.

Makes sense. Yeah. Very interesting insights. You had the idea to start Moonbase after Stanford and then you moved to Spain to do it. Why did you choose Spain? Why did you choose to focus on Europe for Search1 Investments?

For me, now is a very good time to invest in search funds in Europe because the growth is quite steep and at the same time there is a need for the type of investor that we are. So there's a need for more investors, funds that are closer to the, to the entrepreneurs. So I really felt that with the model we have or with the strength we have, being in Europe would fit well. Plus, I think Europe is doing really well. I mean, if you look at the number of new searchers that are popping up in France, in Spain and in Italy, especially these three countries, it's phenomenal. So it's a very good time and the growth is really big in Europe.

I think I'd like to clarify obviously that by growth we mean growth of the search fund community and of the search fund arena. Obviously, Europe today is in a recessionary environment like everywhere else around the world. And many people ask us the question, again, why Europe? I think today there are some amazing opportunities just purely because of the recessionary environment. And we're finding amazing businesses with owners that are very compelled to sell because they'd like to retire today and especially in these stressful times, are willing to leave to really give us amazing deals. Another thing that's amazing about Europe are the demographics. I think Europe's demographics have a lot of older people that have businesses, that have family businesses and that allows for a very, very big pool of investments. And we've been seeing that a lot. Europe's SME pool is quite big and the demographics really help from that side.

Yeah. Are there any big differences you see in the search fund process in Europe versus North America or the UK in terms of Or I know like in Asia, it's much more difficult because businesses are seen as something that's passed down between families. So I was just curious if there's any main differences you see in doing business in Europe versus the U.S. europe's.

Family business culture is very strong. So many of the families who have businesses prefer to keep the legacy and would like to have someone come in who keeps the brand and keeps the people. So they don't love to sell to private equity. I'm not sure how this compares to the U.S. however, we see a very strong inclination to sell, to search for entrepreneurs simply because of that, because they in the end become the daughter or the son that the founder never had, which is easier for them to stomach from a cultural point of view versus a a deal that a private equity could offer.

So what's the strategy of Moonbase? Do you have any exit criteria? Are you looking to roll up different companies or do you have any overarching theme in terms of your investments?

We are a very traditional search fund investor, so we are industry agnostic. We are very happy with rollups. I mean many of our businesses we're looking at, they are potential to acquire a few businesses along the way. So we are very open to that and we like that a lot. But we are regular, short term, five to seven year type of businesses that we focus on and we don't do long term plays. And I love this because I think most of the investors are of that kind. So we're quite similar to the rest of the community, at least here in Europe. Most of the investors here in Europe are within traditional search fund criteria where it's a business where you take it for five to seven years, try to grow it as much as you can and pay off the debt. And if a few M and A deals come along the way, then well and good.

Probably the easiest way to go, especially in relatively newer market research funds. Do you have any characteristics of the sort of businesses you'd like your surges to acquire? Basically, Is it typical surge fund strategy of sticky businesses and growing industries or is there anything else in particular that you look for?

So I think we stick to the search fund criteria. So mainly business, as Ibrahim said, it's quite industry agnostic. So from there, as long as a business tends to the search fund criteria, we're we're quite happy. Obviously we have some additional house criteria we like to call it, but they change again based on the the time. So now we have some inflationary and recessionary resistance criteria. So this is there but then also we tend to make sure that businesses are not owner expert based. So for example, you would never get a law firm, for example, and, and take out its main lawyer. They might have a lot of the criteria you're looking for. But as soon as you get partners out and you have that business, you really are left with nothing. So you need to make sure that the business itself is not owner expert based. But I guess that's pretty much it. Yeah.

Yeah. And when it comes to financing, does that change depending on the countries I know here in the U.S. searchers will make use of small business loans or sometimes do seller financing. Is that something that your searchers explore at all? And is that even possible in Europe?

In Europe, most of the cases are regular commercial banks and mezzanine finance. So you have, in many cases you get leverage up to 60% in this range, anywhere between 55 and 65. And it's less than the numbers we hear in the US where you have much bigger numbers and the government is part of that. So no, in Europe it's commercial banks mostly. And up to 60% leverage is what you usually get.

Does that impact the size of businesses your searches are looking at or your investment strategy at all?

Or it becomes a problem if you find a large business, because when it's a large business and you only can get 50 to 60% leverage, the ticket per investor becomes quite high. And search fund investors, on average, don't want to put a million euros in one deal. They prefer on average to be a bit smaller than that in large deals. Yes, it could be a problem and it leads some investors to exit the deal. But in smaller deals it's fine.

We spoke this a little bit already. But do you see the standard search fund equity model changing at all or is it here to stay?

I think it is quite stable and the consensus around it is very strong. However, I see the search fund world growing tremendously over the next 10 years. And the more it grows, the more you will have different types of searchers and the model will have to adapt because competition will push it to adapt. But I don't see us anywhere close to this phase yet. I think for the next five to ten years the model will stay intact. And then as it grows, you'll have people also focusing on turnaround or working with searchers who are maybe not as qualified as the ones we work with now, and you need to give them more support. So I think the model in general will have to adapt over the time as much when it becomes more crowded. But at the moment, I don't see it changing soon.

Why do you think that search funds haven't received more attention from PE yet when they have such a high IRR and all the benefits that you've listed?

So I think the, the whole premise comes back to the cycle. So search funds, yes, have been around for 30 years, but if you really look at how they've ramped up, it took some time. So the first search fund, maybe back in the 80s was great, but it took seven to eight years up until that next search fund came about. And then it's growing, now it's growing quite exponentially. But it took time really to start from, from zero. Especially that the cycle time is quite high.

And on top of that, private equity guys prefer to invest larger tickets. So for them half a million euros on average is quite low. And also in many cases they want to have more control than the model we are dealing with. So it's not as attractive to private equity investors. It's more something for either regular CEOs, business persons who want to invest in this type of asset class and want get a kick out of mentoring and working closely to an entrepreneur, or funds that have the mandate to invest in such funds, but private equities, it's all exciting for them, I would say.

Makes sense. Why do you think now especially is the time to invest then?

I think there are two aspects to that question. So the first one, obviously now there are some great deals because of, as we mentioned there, because of the distressed economy. So there are a lot of those compelled sellers that would be willing to offer up companies at deals that you couldn't find earlier. So that's the short term, short answer. But I think there's another more fundamental answer. And because at the end the pool of businesses that adhere to the investment criteria of search fund is, I won't say finite, but is quite stable. So it's, it's not something that's going to grow very, very fast. So you have a pool of businesses and those businesses, you have a lot of searchers that are increasing. So as the amount of searchers increase, you will start to have more collisions, you will start to have more and more searchers colliding at the same acquisition. And at that point, if once those collisions increase, returns will decrease because you will have situations where purchase prices will start to acquisition prices will start to rise just purely because you have more and more searchers want the same business and you will start to. That crowding effect could become an issue that could in the long run decrease the returns of search funds.

So now is a time when this didn't happen yet. So we believe now is a good time to invest and grow your presence in search funds.

I think we're definitely right at that point and being in Europe now, I think especially as it is getting a bit more credit in the US already. Who are your ideal investors? Who do you look to to invest in Moonbase and who would make the most sense as an investor for Moonbase?

We are creating a. So we're now raising our fund and we are looking to create a different type of fund. We want to fund where the investors, our LPs are invol in our deals and are also supporting our searches. So I don't believe very much in the regular private equity type fund. When it comes to search funds, I think search funds require a lot of support from their investors and hence we are looking to do a smaller fund, 10 to 15 million euros only. And we are looking to get a small number of investors. So we have a high minimum ticket and we look for investors who can add value, who are willing to stick out the neck for a searcher, who are willing to serve on a board or willing to help in some way. And I think this model, I hope it will grow into a type of fund which is for search funds because currently the funds we have is just a copy of what the private equity has.

Very exciting. So back to the white paper. What would you say is the biggest takeaway from it? What would you want people to know after you've completed this?

The mix of attributes that search fund has from the venture capital world and from the private equity world makes it better than both of them. Of course I'm biased, but my opinion is you get the entrepreneur, which is the huge success in startups, and you get the diversification that VCs offer. So VCs because of the diversification and because entrepreneurs are doing good results. And on the other hand you get the fact that you're buying a private equity type company which is stable and is can go visit the company, see the clients. It's not a vision, just. Just a dream. It's more of a asset that exists as well as the leverage, which is a huge thing that venture capital don't enjoy and makes a lot of returns for the private equity. Now search funds is putting both of those together. You have the best of both worlds, I'd say. And for me that's the insight which excites me most about search funds.

Definitely. And I'm sure there'll be a lot of MBA graduates or others who are looking to become search fund entrepreneurs listening to this podcast. What advice would you give to them if they're interested in becoming a search fund entrepreneur? What are the characteristics of a good search fund entrepreneur and what should they be doing now if that's what they want to do soon or eventually?

The one thing I would tell them is there is never a time when you will feel ready to do entrepreneurship in general. Entrepreneurship is scary and entrepreneurship is not something you can predict easily. So you need to basically jump in the water. So I would tell them, search fund entrepreneurship is not for everyone, but if it's for you, if you're someone who, who gets excited by leading a company and likes the type of finance, accounting, sales, or not, I mean, not really a techie or you're not just a developer who wants to create an app, then I would say just jump in it. And there is so much support that you will get from the search fund community. Search on community is amazing. I mean, you're talking to people who will always help you out and support you, whoever you are, Investors and entrepreneurs, we are all in a way linked to helping each other out. So I would say just reach out to these guys, talk to people and see if this is for you or not, and just jump in the water and do it. It's. It's a great journey, very rewarding and I, I recommend it to anyone.

All right. I think that's a great place to end it. Thank you so much, Khaled and Ibrahim. Really enjoyed having both of you on.

Thank you, Nick.

Thanks, Nick. It was a pleasure.