- Fund: Gypsum Ridge Capital
- Search type: Classic search fund
- Partnered/solo: Partnered
- Stage: Search
- Location: Chicago, IL
- Alma mater: Chicago Booth (MBA), SMU (MS), Indiana University (BA)
Matthew Taylor and his business partner are a year into their search at Chicago-based, classic search fund Gypsum Ridge Capital. Matthew’s a Chicago Booth grad with a predominantly military background who learned of search funds during his brief stint in private equity.
Highlights of Matthew’s interview include:
- The importance of cohesion in LP resources and expectations
- Off-the-beaten-path sources of acquisition targets
- The virtues of recurring v. repeat revenue businesses
Editor: What’s your personal background?
Matthew: After college at Indiana University – Bloomington I spent 10 years in the marine corps and then a little over a year in Los Angeles working for a geopolitical risk management consulting firm.
I earned a masters in finance from SMU and then worked briefly for a private equity firm in Dallas. I enrolled in 2015 at Chicago Booth where I earned an Executive MBA while running my search under the Gypsum Ridge Capital banner.
What brought you to search funds?
When I left the marine corps I thought I wanted to be an investor, so I got my Masters in Finance and took a job in private equity. My experience in private equity was great, but I quickly realized two things:
- My age (I was 34 when I stated at the fund) made me feel old relative to my entry-level peers in the private equity profession.
- What I really wanted to do was run my own business.
One of my mentors at the PE fund who had seen a lot of PPMs from searchers suggested that I look into search funds, and I was immediately hooked. I spent about two straight days doing nothing but read all of the Stanford search fund primer materials and then set about getting in touch with search fund entrepreneurs and investors.
After a few conversations I decided that search funds were for me and I set out on a 6 week “informational meeting” campaign in which I talked (in person whenever possible) to as many members of the search fund community as I could. At that point I wasn’t even asking for money – I was simply calling people up and saying “Hey, I’m not a 27 year old with a Stanford MBA – I’m an ex-marine in my 30s and am trying to figure out if I’m qualified to run a search and would like to talk to you about your experience.”
I learned from these informational meetings what are the right and wrong reasons to do a search. One search fund investor made a comment that really helped crystalize my thinking when he said that I’ve “Gotta figure out if I want to be an investor or a CEO.” Did I want 10 fingers each 1 inch deep in 10 different pies? If so, I needed to continue to pursue my career in PE. If I wanted to be elbow deep in one company, however, a search fund was the right move.
You’ve been searching with a partner – how did the two of you get together?
My business partner and I met in officer candidate school back in 2005. We had our heads shaved together, bunked together, became great friends and knew early in our relationship that we wanted to eventually go into business together, but we had no idea what we wanted to do until I pitched him the search fund idea.
He and I are a good match – on top of our shared military experience he’s got great business operations experience and I’ve got the financial chops.
What was your fundraising strategy?
We started work on our PPM soon after I enrolled at Chicago Booth in late 2015. We started soliciting investments in October 2015 but didn’t get going in earnest until January 2016. We found it difficult to make progress during November and December 2015 due to the holidays.
We wanted to build a diverse LP base and were picky about the sorts of investors we wanted to have in our fund after learning from several experienced searchers of the importance of cohesiveness in one’s LP roster. What cohesiveness means in this context is that LPs must be aligned on the following:
- Checkbook size
- Risk appetite
- View of what’s important in an acquisition target
We didn’t want, for example, to have one investor looking to write a $250k check and other hoping to invest $2M.
Similarly, we didn’t want one investor looking for a high risk/high return moon shot opportunity alongside another investor who valued preservation of principal and dependability of cash flows. Believe it or not, the pool of prospective search fund LPs contains individuals and institutions situated across a wide spectrum of risk appetite and it can be challenging to determine an investor’s expectations.
What does your LP roster look like and what are their expectations?
The core of our investor base is traditional without being dogmatic. They’re looking for the classic search fund acquisition target attributes of profitability, competitive advantage, diversity of customer base, and dependability of cash flows, but also have faith in our ability to pursue a higher growth profile opportunity if we find a compelling one.
Our LPs have reacted in one of three ways to opportunities we’ve described so far:
- We love the investment – we’re in and we’re willing to invest more than our pro-rata share
- We like it but don’t love it – You’ll probably get a token investment from us
- We don’t like the investment
I recommend that searchers think carefully during the fundraising process about why each investor is investing – Does the investor like you as a person? Does the investor like the concept of a search fund? Does the investor like the search strategy you’ve presented?
Investors will behave differently during the search and acquisition processes depending on their motivations for their involvement in the fund.
When did you start your search?
We officially began our search on July 1 2016, though we had unofficially begun our outreach a few weeks earlier because we wanted to get some reps under our belts before the clock started ticking.
How have you used intermediaries?
We’ve run what I describe as a three-channel search:
- Investment banks and business brokers
- Proprietary lead generation
- Stuff in the middle
By “stuff in the middle” I mean getting in touch with people and institutions that aren’t proper investment banks or business brokers but that nonetheless have access to acquisition targets. Examples include:
- Part-time business brokers who do maybe one or two transactions a year
The thing about these guys is that if you have a good relationship with them they might send you deals before they’re broadly marketed. There are some terrific sources out there and we’ve been lucky to get to know a few of them. They’ve been the sources of our most exciting opportunities and while I’m happy to share these sources with other searchers, I’d rather not do so until we get a deal closed 😉.
Have you found yourself in competition with other searchers on potential opportunities?
We’ve noticed that the volume of searchers seems to be increasing and that a lot of owners we encounter are talking to or have talked to search funds. It’s been particularly noticeable in the brokered channel where you’ll often find a deal being marketed by a small investment bank to 5 different search funds.
That said, there’s a professionalism among searchers – particularly among members of the Chicago Booth search community – that seems to prevent people from trying to poach each other’s deals.
What would you say is your competitive advantage as a searcher?
My partner and I have found that we’re not going after the same sorts of businesses that most searchers are pursuing. We’re a couple of old guys (relatively speaking) with military backgrounds – We’re not looking to run a SaaS business or to get into anything particularly technical. Our ideal acquisition target is something a little more blue collar in which success hinges on our ability to lead teams of people. We’re proven team leaders and we think that owners recognize us as such.
What roles do you and your partner hope to assume post-acquisition?
I plan to take responsibility for external matters like business development and my partner intends to manage operations and internal processes. Broadly speaking, we’re looking for a relatively simple business with a strong product/service offering and an opportunity to grow sales.
One route we definitely don’t intend to pursue is a roll-up strategy. To pull off a roll-up strategy you need the right set of LPs and you need to have exceptionally tight relationships with them. It seems like a lot of search fund investors have been burned by roll-ups, and we’re not sure how to go about pulling together that sort of investor roster.
That said, we have looked closely at one deal that would have a potential tuck-in opportunity one or two years in, but that’s the extent of our post-acquisition corporate development ambition.
How big of a company do you want to buy?
We’ve built an LP base that doesn’t want to buy a very small company and we definitely have an EBITDA floor of about $2M.
We fear that buying too small a business could create two problems:
- We’d have limited operating leverage because additional hires would quickly eat into EBITDA margin.
- Our personal economics simply get worse the smaller a business we operate.
For the first point, consider that if you’re down around $1M EBITDA or lower then adding a new salesperson is probably going to cost you 10% of your EBITDA margin.
The second point is just cruel, basic math – doing a great job as an operator of a $3M EBITDA business results in a bigger payoff than if you do the same great job on a $1M opportunity.
What commercial characteristics of an acquisition target do you consider to be most important?
How important is recurring revenue?
We definitely don’t want to be in a situation in which we have to hunt for our dinner every night. Recurring revenue is therefore ideal, and we define it to be a customer relationship in which the customer has to keep paying you in the hypothetical event that he or she forgets to cancel your service.
That said, recurring revenue is absolutely not a requirement for us – There are lots of companies that do dependable repeat business. These sorts of situations arise under one (or both) of these conditions:
- Switching costs to customers are very high
- The business has few direct competitors and customers therefore have few choices
How important is customer diversity?
All things equal we love customer diversity as much as the next acquirer, but the importance of customer diversity depends completely on the nature of the industry.
- For example: If you’re a B2B company and there are 10 possible customers out there and you have 2 of them locked down, then we might be comfortable with that high concentration as long as the customers have only a couple of options from which to purchase the sort of product or service that you supply.
On the other end of the customer diversity spectrum, we’re categorically opposed to acquiring a B2C business because we fear the speed with which consumer preferences can change. We simply don’t feel qualified to manage a consumer business right now, and would prefer to manage a B2B company that depends on slower-evolving business processes.
How have you been challenged personally during the search process?
I’ve struggled most with my tendency to fall in love with certain acquisition targets that I’ve found compelling. It’s important to remain dispassionate no matter how much you like a business, and it gets harder to do so the farther down the road you get with an owner of a business you believe to be great.
The most exciting moments in our search have come when I believe I have asymmetric information on an opportunity and that this information tells me that the opportunity is great while others might think it’s not-so-great. Those moments, however, are the most dangerous because you may simply be deluding yourself into believing something about the business that isn’t true.
I’ll have discussions with skeptical LPs who argue against the opportunity, and I’m sitting there thinking to myself “I know this business and you don’t, and that’s why I’m right about it and you’re wrong,” but the reality may be that they’re right and I’m just head-over-heels in love.
In summary, self-awareness is both extremely important and hard to achieve, though I think having a good partner helps with this challenge.
Do you think now is a good time to raise a search fund?
I don’t think it’s a good time for most people to raise a fund. The demand for small companies is high from both other searchers and lower middle market PE funds, so it’s hard to get a good company at a fair price.
I counsel a lot of guys considering search funds to ask themselves honestly: “What makes me different? What separates me from the other searchers out there looking for the same sorts of companies?”
One myth I’d like to dispel is that a search fund is a shortcut to private equity – it simply is not a substitute for PE, and I wonder if the security (salary, validation) provided by the traditional search fund pulls some people into the business who really don’t belong in it.
One final piece of advice is that economics are a lot better for searchers who self-fund their search, and that it’s easier to stomach the acquisition of a smaller business (for which you’ll see less PE competition) if your personal deal economics are better.
Thanks for your time, Matthew!