Rick Ruback
Appearances
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
It is flowing. Yeah, your surmise is exactly right, Patrick, and Rick's comment is exactly right. What we see today, it's funny, we started this podcast by saying maybe there hasn't been much change, but indeed there hasn't, like all your other interviews, Patrick. So Rick is right, it's flowing. When we look at the market today,
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
There are more investors who want to get behind talented, well-prepared searchers than there are well-prepared searchers. So the choke point is this number of searchers, even though that's grown quite a bit. But there has just been a huge flow of capital.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
not on our list is growth. Not because we're against growth. We welcome growth, but you don't need growth in this market because good companies sell at attractive prices. And Rick came up with this expression that we've both embraced, which is the magic is in the multiples in this market. So if I were to knock off the list that Rick and I iterate, the first one is recurring revenue.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
We really want high quality revenue. And there are all types of different recurring revenue from the contracted revenue that's impossible to pull out to sort of actuarially repeating, but very high quality predictable revenue so that when you show up in your office every January 2nd, 80 or 90% of the revenues from last year, you know, are going to repeat this year. It gives you great stability.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
It pairs nicely with financial leverage. And it allows you to be on the offense in marketing, meaning that all of your marketing time is basically spent growing, not replacing. So that'd be one. Low customer and vendor concentration.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
That doesn't occur so much in big private equity where you're dealing with big companies, but it occurs a lot with small companies where they have one big legacy client. And so you really want to try to avoid concentration with customers or vendors would be number two. Third, avoid economic cyclicality. Again, it pairs poorly with the financial leverage you'll need to buy this
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
To Rick's point, often we have people express astonishment to us that the newly minted MBA who has maybe five or six years of middle managed experience can go into a business they've never operated in. And the percentages are very high for successful operation of that business. And how can that be?
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
And the reason it can be is partly they're talented, energetic people, but it's the point Rick has just made, which is they're selecting for businesses that they feel they can fit with and learn how to run. They're not randomly picking businesses on this dimension. They're choosing very carefully because they're aware of that risk too.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
Right. And when we call them, they say, it's just like running a platoon.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
I thought it was so interesting. So what Rick's referring to is we assemble a library of recent small company purchases from a network of cooperative brokers. And the students filter through those and then come up with a company they really like. And then they break into groups of six or seven of our students who have done the same thing.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
And they collectively come up with which is the best company to buy. And so you have 14 or 15 groups now in our class. And what, about 100 companies, about 100 sims that they've paged through and looked through. And the result is they come up with about 12 different companies. There's no consensus on this. They're different.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
I think on this point, we arm our students with this list that we've just gone through. It's a filtering criteria. But the truth is, you're never going to find a company that has all of those boxes checked, particularly if attractive price is on the list too, which it surely is. You're just not going to find that have all of those qualities.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
And so the piece that we really try to tune our students into is that they have to develop judgment about how good is good enough. And they do that by, as Rick and I like to say, bathing in deal flow. And eventually you start to see what different qualities of companies are. And you see that next company, you say, okay, it has five of my seven criteria, but it's in the upper quartile.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
So I ought to keep working on this because this is a good one. That's the other piece that's really hard to teach, but you can teach people to keep their eyes open to judgment.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
The way most searchers like to structure their cap table is they like to have 10 or 12 different investors. Some investors push really hard to get a big chunk of the cap table of these funds for the reasons you asked about. But for the most part, searchers want a diversified base of investors for a variety of reasons. They want a variety of advisors and voices.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
They want to diversify who owns their business. And so that naturally invites a dispersion among investors. So I'm with Rick. I don't see the Harvard, Stanford searchers as dominated by two or three or four big institutional investors.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
So Rick and I, since we launched our podcast a couple of years ago, which is really directed beyond the business school campuses, it's got us more tuned into what's going on away from the MBA ecosystem.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
And that's a world which, unlike the business schools, is overwhelmingly self-funded, using SBA loans, tuning into smaller businesses that Rick was describing, this kind of $750,000 million EBITDA businesses. That world today dwarfs what we talk about in the MBA world.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
It's actually got its own population of individual recurring investors writing quite small checks for the reasons of the math we discussed earlier. It's got many times the number of participants
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
all of whom are able to get this favorable government-backed financing, line up investors, buy these attractive businesses at low multiples, and often don't have MBAs, but have a lot of useful professional experience or just outside this top MBA schools. And it is a big opportunity. big place out there. Rick, would you add anything to that?
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
I think your description is exactly right, Patrick, which is the seller who is the center of the bullseye for searchers is someone who is an expert in this product or service and started their business and spent 25 years building it. And now they're 65 years old and have run the business for 20 years and several things have changed. One is the business has gotten larger and it really, at the top,
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
no longer needs an expert artisan, but it really needs a trained manager. And this person isn't that in most cases. If it's a blue collar business, maybe it was an HVAC guy who got fired, bought a truck, built up a business. It makes a million and a half dollars a year, but it really needs a manager at this point because it employs 60 people and has lots of customers.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
Second, the business is at a size where he really doesn't have an understudy CEO in that business. It's not like a larger company, which has a thick bench of talented middle managers. And so he needs someone or she needs someone who can not only organize the capital for the transaction, but can then step in and run it because he has no internal successor. Because if he or she did,
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
They could retire and just keep owning the business. Some businesses are suited to that, but most businesses aren't. And the third thing is they've reached an age where, as Rick and I like to say, they now have more money than time and they're behaving accordingly. They don't want to work Fridays anymore to launch a new territory, but a searcher who's not wealthy and energetic and hungry, they do.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
And levered. And levered. And levered. And so this is the catalyst moment. This is why these sellers sell to searchers. And this is why the searchers see opportunity there. But Rick, I don't know if we have a view that somehow we're at a peak of supply.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
I agree with that. And dealing with the other part of your question, Patrick, I think when you list off the businesses that you did, and Rick and I could list more, but just for our listeners, roofing, HVAC, veterinarian services, there are a whole series of these that have attracted the interest of searchers. And when Rick and I look at them, the services are all different at a superficial level,
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
You're fixing your roof or you're taking care of your dog. But when you look beneath that, the reason the searchers are attracted to them is they all look alike when you're looking at the economic characteristics. They have recurring or reoccurring revenues. They have a very diverse customer base, vendor base.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
They're not economically cyclical because you have to purchase that service when something prompts that. And that's why searchers are drifting into these areas. And it turns out that amazingly, despite all these smart people looking for these opportunities, it seems like every year or two, there's a moment of epiphany and, oh my goodness, there's another area.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
There's overhead garage doors or there's automotive repair. And a new area becomes hotly pursued like HVAC began to be five or seven years ago. I think it's these businesses that have these characteristics that are being unearthed.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
I would say that's extremely rare, but I would say what's not rare is if you persistently invest in this space, you will get money multiples of like 3X, 3X, 3X, 3X, 8X, 3X, 3X, 3X, 10X, 3X, 3X, 3X, 7X. You can make a living doing that. That's really okay. You might have some 1Xs mixed in there too. Rick's right. You'd have a few 1Xs mixed in there too.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
But I think that is much more representative of the space. I think any private equity firm in the world would love to hang their hat on those kind of multiple of invested capital.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
It's the nature of the professional investment management industry that you're basically paid... very much by the amount of money you manage. And so you enter at the bottom end because usually you can raise a small amount of money because that's a very fruitful part of the market. Those people who go in there and do a great job have more money offered to them and they raise a larger fund.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
And to make sense of that portfolio, they buy bigger companies. And so it goes. The most talented teams just move up in assets under management. They move up in investment size and they leave that space that they were so good at making it available to new entrants in the market. It happens in no other industry, right?
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
I mean, Coca-Cola executives don't wake up and say, oh, we've done a fantastic job here. Let's make garden furniture and give this up. But private equity does that all the time.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
I'd say it's a job, not a company. You misjudge something about the owner, CEO, where it's a set of personal relationships or personal expertise that is really driving the company. And it's not really a business. It's too much her or him. That would be a red flag that you don't pick up in the numbers.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
My guests today are Rick Ruback and Royce Yudkoff. Rick and Royce are Harvard Business School professors who teach their students how to search for, acquire, and run small businesses directly after graduation. It's nuts, but it's been almost a decade since our first conversation.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
This is really unique to small firms. In small firms, the owners, to some extent, live inside of the company. It's routine that in a million and a half dollar EBITDA business, the owner is spending $100,000 on personal expenses and running them through the business. And as a buyer, that's his decision. You're going to add that back to EBITDA because it's really EBITDA spent in another form.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
And that's just common. I'm not making a moral judgment on it. It's just common. But what you have to watch out for is sometimes you see these companies where the owner has just gone wild and there's just this gigantic amount of living within the company. It's not 5% or 6% of EBITDA, it's 50% that's getting added back.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
And the issue you have to start thinking about is not even documenting that to make sure that's true. It's that If this person is so willing to take those kind of risks and color outside the lines, how is he going to treat you as the buyer who, no matter how much due diligence you do, the information advantage is asymmetric and in the seller's favor?
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
And so at some point you have to say, there's an ethical question here that could stab me in the chest. That's a small firms thing. You don't encounter that when you're buying shares of Microsoft or dealing with companies that go into big PE firms.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
And unlike many past interviews that become outdated due to technology or market changes, the core principles they shared about entrepreneurship through acquisition remain remarkably relevant today.
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.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
They explore fascinating developments in the search fund ecosystem, including the bifurcation between funded searchers targeting larger companies and self-funded entrepreneurs finding success with smaller businesses.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
Rick and Royce share their accumulated wisdom on what makes a company worth buying, why the magic is in the multiples, and how their students consistently achieve impressive returns through patient, value-oriented business acquisition. Please enjoy my second great conversation with Rick Ruback and Royce Yudkoff.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
I agree with that. That's the pattern we see again and again.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
Yeah. Rick, I entered academics 15 years ago to partner up with you. You've been in this longer, so I'm going to be really interested in what you say. I would offer two things that we've done consistently. One is the class is extremely practical.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
There's very little theory taught because we think that the students come to this class because they want to evaluate whether they want to do this as a profession. And then if the answer is yes, they want to stack the odds in their favor of doing it. Every time we write a case, every time we develop a teaching plan, we're always thinking about what practical lesson are we teaching these students?
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
And the second thing we do is we bring in the case protagonist. for almost every class. And part of this lets the students ask questions and breathe some additional life into the case.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
But really, the reason we have them there is there are two questions that Rick and I know are on the students' minds, that they can look at this person and listen to this person, and they can answer, do I want to be this person? And can I do what this person does? And that's hard to teach, but easy to show. And so
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
Those are two of the things that I think Rick and I have found are very powerful and students in their end of year evaluations routinely comment on those. So that's what I would offer as things that we've done well. Rick, thoughts?
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
I would say we direct our students to businesses that are capital light. So once they buy a business, and we probably should have put this on our list of qualities, which is superb free cashflow characteristics, we are nudging them to business service companies where EBITDA almost exactly equals free cashflow. And so capital allocation decisions are very episodic.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
They usually center around a tuck under acquisition. Sometimes they're expenses that are really investments like launching a new sales force. And of course, they're taught how to do projections and see what kind of return on expense there is. But I don't think there's a lot of allocation that goes on in these businesses because of the nature of the businesses we suggest they buy.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
I agree with everything Rick just said. I'd just add a couple of numbers that add to this, which is the sense of possibility here. In the United States alone, because searching has become global, there are approximately 3,000 small business brokers, professionals who do nothing but intermediate small businesses.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
There's something like 300,000 small businesses that change hands every year where the seller sells. It is not that hard to get in the flow of this harder to filter and find a good business at the right price with a committed owner. But getting started at it and bathing in a flow of companies, which is how you learn and how you find, that's really not that hard.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
Do you agree with that, Royce? Yeah, totally. That's when these entrepreneurs have really learned what the customer wants and start to come up with programs and service lines that address that.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
Before we go to that, I want to say one more thing. Will Thorndike, who you know well, and we know well, and has been a long time and thoughtful investor in this space, has actually looked at a lot of the data and concluded that everyone sells too early, that the successful companies really compound their success in year 7, 8, 10, 12, and that really there should be much longer holds.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
And I think we agree with that idea because the successful searchers we know really well keep getting better and better and the companies keep growing.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
What takes searchers out more than anything else early, meaning year five or six of operating the company, is that they have 95% of their net worth in this one company and it's a good company, but their capital allocation is just not sensible anymore. And they're an entirely different manager than they were when they were a newly minted MBA.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
They are now an accomplished CEO entrepreneur with seven years of experience. And maybe there's a different economic deal that they could get on next. And in many cases, this propels a sale. which I think, Rick, I know you'll speak to this too, but I think we have questions about that.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
It's a little bit like if you bought a business and went through the J curve of the initial investment and you sold right after that. Here, you finally become a really expert CEO in this business. You've got the business pointed in the direction you want. It's really doing well. Why would you deny yourself the next half decade of that? I think it's a capital allocation issue.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
I co-founded it with someone named Andrew Banks, who had been my partner previously at Bain & Company. And when we started it, it had a strong sector focus, which was different to new in the late 80s and early 90s. Today, it's table stakes in the private equity business, but it was a powerful driver of every partner's success. And he and I ran the firm for a quarter century. We did it for 25 years.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
It was a wonderful experience. Metaphorically, I ran to work every day because I enjoyed myself. What I'm about to say is true about Andrew as well. We started to try and envision how we would reflect on our lives at the age of, say, 75 or 80 looking back.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
And if we spent the incremental 15 years, so not a quarter century, but 40 years running a private equity firm, would we think that that was a really sensible allocation of our professional life? And the answer was no. No, it really wouldn't because 25 years was a great experience, but there are other things in life that are different and interesting.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
That really motivated us to want to do something different. By the way, it helped the firm was doing well. We had a talented group of partners in the next generation who could step up and this would be good for the investors and for them. That was important. But that was really what was driving our thinking. And I will add two things. One is that there was a catalytic event for me.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
I was working late one evening in my office, and my dear friend and longtime partner, Andrew Banks, came in. And I always think of this a little bit like in Charles Dickens' The Christmas Carol, when Jacob Marley comes in and wakes up Scrooge and tells him what the future will be like if he doesn't listen to his partner, Jacob Marley. And Andrew said, Royce, when we started this thing, we had
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
more time than money, and now we have more money than time, and we ought to act accordingly. And I thought to myself, that is really good advice. I'm not going to admit it to Andrew. It'll just ruin him. I guess I just admitted it. Hopefully he doesn't listen. But those were the reasons for leaving. And when I left, it was very disorienting because I was leaving something I was very good at.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
What could I do to replace that? I had the immense good fortune of partnering with Rick Ruback and building this in a partnership with him. And boy, I'm so glad I did it.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
I so agree with what Rick said on this. I think at great institutions, there's a tension between research and practical teaching. Schools have to find a balance because different constituencies want different things out of those institutions. Faculty, alumni, the general public want the benefits of the research and new ideas that come out of them.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
Often the students want a very practical education. And... You're operating one enterprise that's trying to produce both of these, and finding the right balance between those two is like an eternal challenge for a fine school.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
And so I've been very struck being inside of Harvard as a faculty member, how challenging it can often be to deliver both of those, because as a student, you experience the faculty just in their capacity as teachers, and you don't see that there's this huge other component to their careers.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
Do you agree, Royce? I do agree with you, Rick. I would add to the list that these are very smart people. And often when they're dealing with a problem, It's because you could go either way on that problem. And they call for a second set of ears that they trust to listen to this.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
And more often than not, if you force them to make a decision, they would make the same decision you're making, but they just need to hear someone else who kind of understands business and they trust saying, yes, that's sensible. So I think there's a bit of that. Before they jump, they want to get a confirmation from us.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
Why would you do such a stupid thing? This is a really interesting thought because I never considered this. When they suspect they're wrong, they call you. And when they suspect they're right, they call me.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
Royce, what would you add to that? Well, first of all, I agree that that's the major change.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
First or second case we teach each year is a case called Nashton Partners. And it's about two HBS students who actually graduated a few years before we started the program. So before there was any entrepreneurship through acquisition teaching, before it was a thing, they cottoned on to it. And they did a laborious search and they bought a small...
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
And I'd just like to spend a moment adding to what you said and then offer one additional change, which is that in the United States, we have this amazing opportunity that's created by the SBA loan program where every American citizen has the right to borrow up to $5 million in this government-backed loan program.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
municipal extermination company that had great revenue qualities. And it took a few years to figure out how to crack the code. Once they cracked the code, it led them to seven years of fantastic growth, both organic, but also acquisitions. And they sold it for a huge price. And it's kind of a template journey of how
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
People who were never in the municipal extermination business figure out a business, how they find a company that has the qualities you want to find in these businesses, why they can do a job that the owner before couldn't do. It's sort of a way of shining a light on this and saying, there are many forms this can take, but this is a good picture to remember when you think about ETA.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
And I just love that case because it explains the journey we're going to take them on, which is a great place in my heart. We've been teaching it since, I think, 2008.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
which allows them to buy an established, proven, profitable business with up to sort of 80% or 90% leverage. And that in turn enables these acquisition entrepreneurs to line up the equity they need, give it a very attractive return, and own 70% or 80% of the business, even though they don't have any capital but for their sweat equity and talent.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
Yeah, I don't think it's a low status thing. If I were to think about the people who choose to go into large enterprises, the things they would say are important to them. I used to believe they're not rational. And if they only listen to the preachers, Rick and Royce for long enough- But what I've come to realize is they have a bunch of values that are sensible- And different. And different.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
Thank you, Rick. That's exactly right. And those would be, in no particular order, they want to work in an enterprise that have lots of resources so they can do the polished work that they've been trained to do and they get satisfied by.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
They want to be surrounded by coworkers, colleagues who are like them, highly educated, who show up at work wanting to be the best they can be because work is a social activity. They want to be part of something larger than themselves, not limited to, but including a great brand name. They want to be part of the team that brings Coca-Cola to China.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
And so these are things that are really important. And if you say, well, wouldn't you rather be more independent and not have a boss? And they'd say, sure, of course, but I want these other things more. And I think that's the people who look at this path and say, it just isn't a fit with me.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
And to Rick's point, that's proving to be an attraction to many very talented people. The other less important change that I'd add, but still notable, is when Rick and I started teaching 15 years ago and through 10 years ago, our entrepreneurship through acquisition program, everyone who went into it wanted to be an entrepreneur and run their own company.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
I'm looking forward to that.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
This was really great. It was as fun this time as it was 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 more recently, we've seen a minority stream, but a meaningful minority of people who kind of look at this opportunity as independent sponsors. They go into it. They don't want to run a company, but they want to buy a series of small companies and put managers in. And Rick, I'd say that's a change. It's not as important as the one you mentioned, but it's certainly notable.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
Yeah. From investors, I'll break it into two groups. In the funded search, Stanford has done a good job of tracking returns on funded search through an annual report they do since forever. And it's shown that the returns to investors are in the low 30s of IRRs. So if you compare that to big private equity, the average returns are sort of in the low to mid teens.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
So it's a huge premium you get from being in this market. We think those numbers are slowly trending down a bit, but they're still way above the closest asset class, which is private equity. In self-funded search, where you have these students raising money to buy $1 million-ish EBITDA companies, $1.5 million, and buy them at four times, and finance them at 80%, the math is just extraordinary.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
If you buy something for four times, you're generating a 25% return on assets before any growth. You lever that at 80% with, say, debt that costs eight or 10%, and the return is astronomical. you pay your investors a portion of the common equity that gets them to a targeted return of 35%. That's the market clearing price in self-funded search.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
And the searcher is able to keep 60% or 70% of the common stock for themselves. So deals are smaller, but the rewards are high. So that's the kind of math The one other point I'd make is on risk, particularly on the self-funded side.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
You're buying at multiples that are so low that generally, even when things don't go right, the cash flow yield pays down the debt very quickly and mitigates a lot of the downside. So it's a pretty good trade. You can see why people get interested.
Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
It is hard to get a zero.