Invest Like the Best with Patrick O'Shaughnessy
Royce Yudkoff & Rick Ruback - Entrepreneurship Through Acquisition - [Invest Like the Best, EP.423]
Tue, 13 May 2025
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 business directly after graduation. It has been almost a decade since our first conversation, and unlike many past interviews that have become outdated due to technology or market changes, the core principles they shared about entrepreneurship through acquisition remain remarkably relevant today. 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. 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 conversation with Rick Ruback and Royce Yudkoff. For the full show notes, transcript, and links to mentioned content, check out the episode page here. ----- This episode is brought to you by Ramp. Ramp’s mission is to help companies manage their spend in a way that reduces expenses and frees up time for teams to work on more valuable projects. Go to Ramp.com/invest to sign up for free and get a $250 welcome bonus. – This episode is brought to you by AlphaSense. AlphaSense has completely transformed the research process with cutting-edge AI technology and a vast collection of top-tier, reliable business content. Invest Like the Best listeners can get a free trial now at Alpha-Sense.com/Invest and experience firsthand how AlphaSense and Tegus help you make smarter decisions faster. – This episode is brought to you by Ridgeline. Ridgeline has built a complete, real-time, modern operating system for investment managers. It handles trading, portfolio management, compliance, customer reporting, and much more through an all-in-one real-time cloud platform. Head to ridgelineapps.com to learn more about the platform. ----- Editing and post-production work for this episode was provided by The Podcast Consultant (https://thepodcastconsultant.com). Show Notes: (00:00:00) Welcome to Invest Like the Best (00:05:23) Changes in the Small Firm Acquisition Space (00:06:52) The Impact of SBA Loans on Acquisition Entrepreneurship (00:08:55) The Evolution of Entrepreneurship Through Acquisition (00:10:09) Risk and Return in the Search Fund Model (00:13:38) The Role of Investors in Funded and Unfunded Searches (00:19:33) Criteria for a Good Acquisition Target (00:28:36) The Growing Popularity of Self-Funded Searches (00:43:21) Challenges and Red Flags in Small Firm Acquisitions (00:49:47) Exploring Margin Expansion and Growth (00:51:02) The Impact of Practical Teaching in Business Education (00:52:12) Keys to a Successful Business Class (00:53:30) The Role of Theory in Practical Business Education (00:55:29) Challenges and Rewards of Teaching Business (00:57:46) Capital Allocation in Small Businesses (01:00:50) Advice for Aspiring Business Searchers (01:03:45) Value Creation and Business Lifecycle (01:08:20) Deciding to Leave Private Equity (01:11:20) The Future of Higher Education in Business (01:16:06) Ongoing Relationships with Former Students (01:18:45) Favorite Business Cases to Teach (01:24:46) Encouraging More People to Pursue Business Ownership
Chapter 1: What are the changes in the small firm acquisition space?
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Chapter 2: How do SBA loans impact acquisition entrepreneurship?
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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.
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.
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Chapter 3: What criteria make a company a good acquisition target?
Whereas yours, when I listened to it, you could argue we could just republish that one and capture a lot of the spirit of the power of the sort of entrepreneurship and entrepreneurship through acquisition and investing that you teach and advocate for. One, I think that's so cool. I'm so excited to do this with you both again.
And I guess my opening question with that observation is what has changed the most in the last eight to 10 years in your class, in your students, in the people that you back with financial capital and strategic help? What are the things that have changed since our first conversation in 2016?
Do you want me to take a crack at that, Royce? Yeah, you go first. I'll lob in some if I have it.
Okay. So when we talked in 2016, nearly a decade ago, as you say, first of all, I had hair. So that was a big difference. You look great. Thank you. But aside from that, one of the things that has really changed is that the small firm space, the small firm acquisition space is really bifurcated.
With the funded searchers really moving up market into much larger deals, the averages keep moving around, but think $20 million of average total enterprise value.
And the unfunded or self-funded or spouse-funded or family-funded, whatever you want to call it, where they don't take investor money at the time they begin their search, so unfunded for me, those unfunded deals have actually gotten a little smaller. So people have discovered that there are great opportunities buying below a million dollars of EBITDA, thinking about, well, what if SDE is $600,000?
Can I get by? Can I grow this business? And we're finding more and more students buying smaller businesses at lower multiples, think three, four, and other students going in the opposite direction, buying much bigger companies at much higher multiples, think six, seven, eight. So it's really bifurcated in a way that I wouldn't have predicted 10 years ago.
Royce, what would you add to that? Well, first of all, I agree that that's the major change.
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.
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Chapter 4: What challenges do entrepreneurs face in small firm acquisitions?
Chapter 5: How do funded and self-funded searches differ?
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.
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.
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.
And I think that's growing because people are saying, wow, I don't want to pay eight times to buy a $2 million EBITDA firm. So maybe what I'll do is pay three times and buy three and a half $600,000 EBITDA firms or something like that. And so they're buying low and sometimes the synergies and roll up potentials, but oftentimes they're just running three separate companies.
But they're getting critical mass and they're getting some diversification and some drive and some opportunity to apply their talent. So it's pretty exciting. If I could add just one other thing, 10 years ago, this career path was viewed as quirky. To pick a word, Royce may have a better word, but quirky.
We used to say jokingly to students that we would get calls from their parents and they would say, what did you do to my kid? I mean, my kid graduated from a really good undergraduate school, had... five years of really good work experience. And now they're sitting in their pajamas all day, staring at a computer screen with headphones on, sort of talking to themselves.
Is this a depressive episode? Is this some sign of psychological break? Do we need to get our child, man or woman, do we need to get them therapy? Because it was such a quirky and unusual career path. Now it's become a much more traveled path.
And our students can look back and whether they're men or women or veterans or English majors or engineers or private equity people in their former employment, they can always look back and say, wow, there are literally dozens of success stories that I can look back on. So it has now become a well-traveled path and a more acceptable path.
Can you help frame for those listening the sort of risk and return statistics that you've observed in this world in totality? So in the entire history that you've been involved with it, but maybe even specifically tuned to say the last 10 years, the whole roll-up thing really has become a thing.
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Chapter 6: What risks do searchers encounter in business acquisitions?
But you can certainly buy the sub-million high-quality business at Forex.
So if the constraint is companies worth buying, it's the right time to talk about what those criteria are that you teach your students for what makes a company potentially a good acquisition target.
I would love you to just riff on what those criteria are, how you arrived at them and how they've evolved in as much detail as you want, because obviously it's an incredibly important part of the consideration.
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.
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.
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.
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
Rick, are there others you'd want to put on this list? Well, I think you need to buy a business that you can manage. I like to say if you're allergic to fur, don't buy a pet shop. And I mean that to be emblematic of a whole bunch of things. So many businesses I could not run. I could probably run a landscaping business, but I don't think I could run a biotech.
So I think you have to have a business that you can use your talents or develop talents to run. You don't have to know the business. You don't have to be an expert in whatever the business does, but you have to be the kind of person who could learn that.
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Chapter 7: What is the outlook for the future of small business ownership?
What we don't find, at least if we find it, we throw it away really quickly, is people investing in very fatty software, the latest computer app or social media, whatever it is. So there's less of that, but there are, if you will, the business of established software, improving it, growing it, maybe migrating it to the web, but that the market is nichey.
That seems to be a pretty sustainable investment thesis.
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,
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.
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.
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.
And sometimes what they're doing is bringing management talent and skill to a segment that didn't have that management talent and skill. We just did a podcast with one of our former students, Logan Leslie, and he's doing a roll-up of auto repair facilities.
And what was fascinating is that it used to be what would happen is you can imagine, think about an eight to 10 bay automotive repair facility. The way this gets started is somebody starts repairing vehicles and the person is probably a pretty good mechanic. And pretty good at repairing things.
And now as he gets bigger, assuming it's a man, as the place gets bigger, suddenly you're now hiring and ordering and doing accounting and doing a whole bunch of back office stuff. And then as you get to a certain size, the founder is no longer pulling wrenches and changing water pumps. All they're doing is management activity. And you know what?
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Chapter 8: What are some common red flags in small firm acquisitions?
I was going to say, and often they call me when they have this sense that they might be wrong. Because you always say, Rick, feedback is a gift. I say feedback is a gift. And I'm willing to say to somebody, that's really stupid.
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.
I think that's correct because you're always more cheerful after this. I'm like, what happened to these students? Why do they want to buy such a crappy business? And you're like, oh, I talked to so-and-so.
They have such a great deal.
It's 80% recurring revenue. And I said, I don't get those.
They call me with a pizza joint.
I guess that's why you're such a great long term partnership. Yeah, that's right. Since I've interviewed you both before, I've already got to ask you my traditional closing questions. I have to come up with a new one this time.
And what I thought that would be fun is to ask each of you what your favorite case has been to teach your students and maybe tell us a little bit about that case and why you like it.
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...
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