E145: Is a 35% IRR Really Achievable? Exploring Search Fund Returns

We ended up finding a security business called, at the time, UCIT Online Security in Toronto. And six months later, we bought it from the entrepreneur.
And how did that play out? Amazing. It kind of exceeded my expectations.
So we bought this $5 million revenue, $2 million EBITDA strip mall security business. And the entrepreneur, Sidney, agreed to stick around and kind of help us run Toronto sales while we focus on strategy and growing the business and we grew organically 20-30% a year for the 12 years I was CEO.
We just sold to a strategic as a 150 million ARR business with 2,000 employees, 40 plus offices, five countries. It was an amazing platform for us to kind of completely change the profile of the business and make it the largest independent remote video monitoring company in North America.
What is a search fund? So it's a model for acquiring a small established business where a group of investors would provide funding to an entrepreneur or we like to call them a searcher to go out and find a business to acquire, manage and grow. So they would spend up to kind of 24 months to find that business.
And then they would take over that business and run it day to day. So they would be the actual CEO and or president of the business.
It allows the searcher to take over leadership and create value through operational improvements, market expansion, and strategy changes. What are the historical returns for search funds? There's been over 681 search funds formed in the US and Canada since 1984, when the concept kind of started out of Harvard and Stanford.
And based on a 2024 search fund study by Stanford, we're still tracking to 35% net IRRs and a four and a half times ROI. To play devil's advocate, assuming these kind of returns, why hasn't the space gotten bigger? Why haven't institutional investors piled into it?

And unpack that for me.

The most obvious answer is you're dealing with a micro caps, small cap space where you

can't put real dollars to work.

You're buying five to $30 million businesses with, call it, million dollar checks.

And institutional investors just can't put enough money to work.

And so it's typically been an asset class for high net worth individuals. but that's why it hasn't scaled to kind of the institutional platforms.
Unpack an individual search fund or search fund opportunity and tell me how it's capitalized through its lifecycle. Typically, the searcher would raise, you know, call it 500,000 to a million to find a business.
And that would essentially be funded by 10 or so investors that they've reached out to. And so each investor would have 10% of their cap table.
Then those investors get pro rata rights when the searcher finds the business. So let's say I find the best HVAC company known on earth and I write a 50 page SIM.
I then present it to my investors and say, I want to buy this business. It's doing 10 million of revenue, 2 million of EBITDA.
I want to apply for five times EBITDA. I'm going to put 50% leverage on it.
So I need a $5 million equity check. So each of those investors would have their pro-rata rates for 500,000 in that example.
And they would then kind of buy that business on behalf of the searcher. You run a fund that invests into search fund opportunities.
How do you go about constructing the portfolio? Talk to me a little bit about your strategy. I'm investing in the entrepreneur to then look for the business.
And then I'm investing in the businesses that the entrepreneur buys. So my construct is having at least 10 to 20 searchers a year in my portfolio running and looking for businesses.
I then choose which businesses I want to invest in as my fund. And then my portfolio construct would typically be about 70% through those acquisitions, about 15% in follow-on capital and about 50% in management fees.
How do you look at the TAM of search fund opportunities? And walk me through from a top-down level. The space has grown significantly over the last 15 years.
To give you context, when I did it in 2010, there was no traditional search fund out of HBS. There was no traditional search fund out of Warden.
And there was one other group out of Stanford. And that was one of the first ever Canadian search fund stories.
Now there's dozens

coming from each of those schools doing search. And the reason being is I think the returns speak

for themselves, but it's become more institutionalized. There's larger investors.

There's more of a playbook, call it more of a traditional path now because of the opportunities

in the microcap space. And how does that play into what kind of searcher is attracted to this model? Has that changed the dynamics in terms of who's approaching the space? Great question.
You know, I'd say in my case, we're driving around all across the US and Canada, pitching people, sleeping on friends' couches. We're getting pro bono work from accountants and lawyers trying to craft together this concept of a search fund in Canada.
And now it's a little bit more, you know, this is the PPM templates that typically people use. Here's the five law firms that people use.
So with that, it produces a wider range of searcher. I will say there's still a lot of my personality in search, but there's also a lot more, call it, you know, sales CEOs or technology CEOs or strategic type personalities that would have been probably less interested in the asset class to do the risks 15 years ago.
Three billion has been invested in search and search acquired companies from 1986 to 2023 from the Stanford study. 700 million, 25% of that was in the last two years.
So the asset class is blossoming and the risk profiles are definitely changing quickly. A lot of these searchers are from elite business programs like Harvard, Stanford.
How did they even come about deciding to be a searcher? Maybe I'll give you my example and then we can kind of triangulate. So here I am, right? I'm 27.
I go to the GSB. I spent my summer at a hedge fund.
I'd worked at McKinsey and Morgan Stanley before, but everyone I look up to is a business owner, entrepreneur. So what do I do? Do I go work somewhere institutional to then get the corner office and then wonder what am I doing in my forties when I have dependents? And that's where I stepped back and said, you know, this is a really interesting asset class.
The risk is not taking the risk. I had offers from those three previous employers with bonuses to help pay my tuition one One had prepaid my tuition.
And I ended up having to pay the tuition back. And so when I look at my profile at 23 when I was working at McKinsey, when I look at the salary, who I was living, my roommate situation, my net worth.
And then I look at 29 after the GSB. After paying back my tuition, I had the same bank account.
I had the same salary as a McKinsey analyst. And I actually ended up living in the same roommate in Toronto.
And so it felt a bit bizarro world six years later. But the profile is someone who's not doing it for the monetary reasons.
They're doing it for, call it the career path and the experience. It's a fascinating concept to search on because you find investors that will fund you for two years to go find what you want to do.
It's almost like they're funding a second business school for you. Do you think that model could work in startups? Say a Stanford or Harvard MBA wants to go start a startup, but doesn't know what he or she wants to do and needs a salary for two years.
Could a model like that work in startups? Yeah, it feels riskier, right? So the entrepreneur and residence concept of startups, you're essentially funding someone to come up with an interesting idea that you then want to invest and you're buying a call option on a person. That you'd almost want to receive the deal, right? Unless that person had deep, deep domain expertise.
Here, it's a bit different. You're investing in someone to buy a traditional business that cash flows, that's been around for 30 years, that has recurring revenue.
And so the bet is that this person is going to change the business and make it better. But even if they didn't, you still have a good business.
In that example, the risk profile is very different on betting on the person because they're looking for a seasoned, already proven entity, as opposed to a startup where you're betting twice. Your business is default alive versus default dead like a startup.
Exactly. It's a startup example, you're betting twice.
On the search example, you're really betting once. You're betting on the person, but then when they actually find the business, the business will speak for itself.
In 2009, when we first met, you went and you decided to go down the search fund path and you went to find a company. Tell me about your process and tell me about the deal that you did.
So in 2010, I wrote an independent white paper for one of my professors named Joel Peterson on the microcap opportunity in Canada. And it was clear that that space had opportunity.
And so he's like, I'd be your first investor, Rob. It's a good sign.
So I was like, okay, maybe this concept makes, it's a good sign. So then I decided the risk would be higher if I didn't have a business partner.
So I found a business partner named Eric who lived in LA at the time, having done banking in New York and private equity in LA, but also was Canadian. And we moved back to Toronto and we started our search in September of 2010.
The concept was unknown. So we labeled ourselves more as a private investment fund than a search fund, just because we didn't want to spook people.
And then the deals started coming through. And we ended up finding a security business called, at the time, UCIT Online Security in Toronto.
And six months later, we bought it from the entrepreneur. And how did that play out? Amazing.
It kind of exceeded my expectations. So we bought this $5 million revenue, $2 million EBbitda strip mall security business uh and the entrepreneur

sydney agreed to stick around and kind of help us run toronto sales while we focused on strategy and growing the business and we grew organically 20 30 a year for the 12 years i was ceo we just sold to a strategic as 150 million arr business with 2 000 employees 40 plus offices five countries it was an amazing platform for us to kind of completely change the profile of the business and make it the largest independent remote video monitoring company in North America. So walk me through the economics on the UCIT deal for you and your co-founder.
Sure. In that example, we bought the business with investor capital.
And for that, we had a 30%, call it upside scenario, where 10% of it would invest upon buying the business. 10% would invest over a four to five year investing period, and 10% was based on 20 to 35% net IRRs on the return.
So we actually, in this example, each had 15% of the upside of the business. So you and your co-founder both had 15% in the deal.
How did your investors do? Three years in, we had, I'll call it a board misaligned perspective on EBITDA versus unit economics. And so at that point, we offered our investors 2.55 net return, about a 35% net IRR.
And at that point, about a third bought, a third sold, and a third held. From there, five years into the search, so a few years later, we did an acquisition where it was around a four and a half times net return to investors called 32% IRR.
And then in 2019, we sold two thirds to a private equity fund at an eight and a half times net 30% IRR. Then we transacted five years later to Garta in October of 2024, which the purchase price was confidential.
But you can infer multiples of that. There's a famous search deal, Asurion.
Tell me about Asurion.

Yeah, Asurion was one of the legends of search fund lore.

It was founded in 1994 by two Stanford graduates, Kevin Twill and Jim Ellis, who acquired a

Houston-based road rescue, roadside assistance carrier.

So you probably remember back in the day, we'd all pay $5 a month on our mobile phone

and never use roadside assistance.

Well, Asurian was one of the examples of who benefited from that.

Those entrepreneurs said, what else can we sell into the mobile platform?

They expanded by purchasing a business in specialty insurance for cell phones and thereby entering the mobile phone insurance sector.

Fast forward 20 years, 30 years, they're now the largest mobile insurance provider in the world.

They're one of the largest extended warranty providers in the world, employing 20,000 plus employees. And the returns to the original search funders, investors was over 100x.
And some of them who stuck around would be over 1000x. Tell me about your fund, Legate Partners.
Yeah, so we invest in search fund entrepreneurs in the companies they build. It's a way for me to pay it forward in the community by investing in intellectual horsepower and search fund entrepreneurs and then supporting them in governance support and operational support.

And what industries are you going after in the fund? traditional, right? We're not trying to get complicated. When I read a SIM and it gets

too blurry, you know, commodity trading, I start to say, this is not for me.

So typically business services, software, healthcare, and basic manufacturing industrial. What do you look for when it comes to finding search fund entrepreneurs? There's a half dozen or so criteria, right? So one is educational and professional background.
Have they excelled at everything they've done? Have they been top decile in everything they've done? You're typically looking for business acumen or finance related fields. Second is the skill set, right? So you need them to be very analytical, right? We need them to be numbers forward.
We need them to be extremely likable from a negotiation standpoint. personal qualities, resilience.
We all know how hard this is. Ethics and integrity are critical.

Strategic vision is going to be important, right? They're going to be buying a very small business

and how do they transform and change that business into a medium-sized business. And that takes a specific skill set.
And then I guess the final two are operational expertise, right? Familiarity with the industry practices that they're buying into and the change management that would be required. And then finally, commitment, right? The last thing I need is someone to quit two years into running their business.
I need dedication, action orientation, and a personal investment into the business. You have a bias towards likable CEOs, which I have a bias against, not because I don't like likable CEOs, just my experience has shown me that they tend to underperform unlikable CEOs.
Why do you have a bias towards likable CEOs? Thank you for listening. To join our community and to make sure you do not miss any future episodes, please click the follow button above to subscribe.
I do like likable CEOs, but probably more fair CEOs than likable. And what I mean by that is I want someone who people gravitate towards, right? They're buying a recurring revenue business.
That typically means you need to corral people around you. You need to recruit new talent.
You need to set the culture and then you need to expand. And so we're looking for, in some cases, a builder profile versus a visionary profile.
What do you mean by a builder profile versus a visionary profile? What I mean by that is they already have the concept, right? And so even if they just rinse and repeat the concept, they will have a successful outcome. And so if you bought a vacuum truck business and you're cleaning up storm debris and dealing with property maintenance companies, no need to change the vacuum truck.
Just expand it, right? Come up with new offerings, come up with new customer offers. And that takes a skill set of building relationships, building customers, hiring good people, and versus saying, I need to come up with a whole new concept, a whole new industry, like a lot of the startup entrepreneurs you speak to.
And a lot of these search fund deals have co-CEOs. What are the best practices for making sure that co-CEOs work well? And how do you manage that process? Yes, it's very popular.
Returns are stated to be better with co-CEOs than single entrepreneurs. I think it brings a different skill set, right? I look at my business partner, Eric and I, we were very different.
I was focused internally as the CEO and he was chief revenue officer and president focused on BizDev, M&A and sales. And so that bifurcation of responsibility really allowed us to focus and hold each other accountable.
And what about decision-making, tie-breaking scenarios? How do you manage having co-CEOs in that case? There's two components there. I think there's a level of respect and kind of radical transparency as to how you feel.
And I think with Eric and I having been business partners for 14 years, there was many times we disagreed, but I think that was the healthy part of it, right? How do we get to an agreement that then is best for the business? You also have a board, right? So investors do in the end own the business and they have the governance and they can help tiebreak certain strategic decisions or key hires. I want to unpack that.
So you and Eric have a key strategic decision. It's not, you know, whether to hire this admin versus that admin, it's whether to go into new markets, whether to invest a substantial amount of capital.
What happens when you don't agree? And what have you learned through those experiences? Eric's very aggressive. So he's like, we should be open at 10 offices a year, Robin.
I'm like, Hey, Eric, let's just, you know, do four offices. So how do you kind of get to that resolution? I mean, in our case, we would typically kind of talk with the pros and cons.
We'd kind of come up with rational heroic trees. We would talk about the pros and the risks inherent in that decision.
And in most cases, we would get to an agreement. Or in some cases, we'd agree on certain milestones that would then reset the triggers of making a new agreement on that.
There were times where we might disagree, and that's where we'd bring in our management team, we'd bring in our board members. And so there's lots of ways to kind of tiebreak as long as there's a lot of respect between the two entrepreneurs.
Do you believe in this concept of disagree and commit, meaning you make an agreement and then you might not agree with it, but you have to commit to whatever agreement you make? I do, absolutely. The inaction in some cases versus action, right? And so as an entrepreneur, there's many times I think where our management disagreed, but when we made a decision, everyone had to roll in the right direction, whether they agreed with it or not, because we needed to then get alignment.
We had a concept, one team, one dream, and we had to kind of move forward. And we could always hold ourselves accountable six months later and say, did this work or not? And what's the postmortem here? But to have an unaligned management team or board or partnership would be catastrophic to the business and poison.
Let's say that you knew that a decision was quote unquote correct, but Eric was really pushing for something. Do you always fight for that decision? Do you sometimes let your partner have it, even though it might hurt the business in the short term? And walk me through managing both the partnership dynamic while also managing the growth of the business.
It's business first, right? So our responsibility is to dissent. And Eric and I had pretty rough skin.
There was many a time I think employees freaked out because Eric and I would be screaming at each other in a meeting. We actually really felt in that radical responsibility of not taking it personally and kind of standing up for what was best for the

business. And so there's no question that we should have ever backed down or,

or ever felt like we were doing something for the partnership.

It had to feel like the right thing.

And if that made a decision take a week longer, so be it.

But it also meant that we had to be dedicated to coming up with making that

decision and not just punting.

Sometimes you just needed more information.

It wasn't a matter of who's going to win this battle. It's, you know, what are the nuances of the decision, extra information, extra inputs from other parties? Exactly.
So we might disagree on pricing plan. Well, then let's just have a third party pricing consultant for the next two weeks.
Let's bring in our CFO. Let's bring in our head of marketing and we can have a real conversation here and get to somewhere as opposed to two people in a room battling it out for no good reason.
There's this odd governance in search funds where you have the investors or LPs own a majority of the company, but the CEOs actually have control. How does that play out? In the end, it plays out in a few different ways.
One is board composition, right? So the investors control the board and then therefore control a lot of the big call it productive positions such as CapEx, spending, additional fundraising, change in strategic direction. The second is performance-based incentives, right? So setting the compensation of the CEOs, making sure that earnouts and bonuses are based on achieving specific targets.
Those are some of the ways to kind of align interests. What would you like our listeners to know about you, about Legate, about anything else you'd like to share? I'd like to let people know that, you know, in the end, I've learned a lot over the last 15 years.

And I really loved the small cap space, right?

You can really make a difference.

You roll up your sleeves.

Everyone's doing as opposed to thinking.

And that operator focus isn't private equity.

It typically is much kinder.

The search fund community is focused on the culture and the people of the business and making sure that the first time CEO gets support.

But what's probably been the most aspiring for me is betting on intellectual horsepower over experience.

And that has been amazing to see a 30 year old take a business and transform it when no one would have probably given them a chance otherwise. It's this alternative route to entrepreneurship that may have not happened.
If you have a former Google CS girl or guy that was at Stanford, they're probably going to figure out how to do a startup at some point, but the search fund might create that incremental entrepreneur. Exactly.
Coming out at 29 and having worked at a hedge fund in New York, that's $10 billion plus AUM. To say, Rob, you're going to be running a hundred million revenue video surveillance business with hard hats and steel-toed boots 10 years later, I would have said you were crazy.
But in the end, it was the most meaningful part of my career path so far. What do you wish you knew before starting this whole search fund process over 15 years ago? I always glorify the CEO role until I realize all it is, is dealing with problems and negativity all day.
So you have to be a bit of an eternal optimist. I'd say the resilience that you're going to need in this role is insurmountable, but the meaning that you'll get is way greater than most other career paths.
The other thing I would say is underestimating the talent that you're buying into the business and making sure that they're all feeling like they're part of the story because you're brand new and typically new to the experience and new to the industry. And that can be quite overwhelming for people

that have been around for a very long time in the original business. Allowing and getting buy-in

from everybody. Yeah.
A lot of them have seen Michael Douglas and Wall Street, and that's their

experience with buyouts. And so you have to very quickly let them know you're not that guy or gal

and that you're in it for the right reasons and looking for growth as opposed to restructuring. What is the biggest misconception about search funds? One of the biggest misconceptions of search funds is that people think that the young entrepreneur has no right to running a business and that you need to have a lot more gray hair and experience.
What I've learned is there's a lot you can learn on the job and you put a hardworking, really smart person in a role, they can do wonders a year or two in. Well, Rob, we've been friends since 2009, 2010.
I don't have the exact date, but it's been great friendship and appreciate you jumping on the podcast. Thanks, David.
Looking forward to many more years. Thanks, Rob.
Thanks for listening to my conversation with Rob. If you enjoyed this episode, please share with a friend.
This helps us grow

and also provides the best feedback

when we review the episode's analytics.

Thank you for your support.