Sara Heston – Stanford Search Fund Study 2024 – Ep.232

Hood & Strong LLP – One of the nation’s premier full-service public accounting firms, Hood & Strong LLP provides buy- and sell-side quality of earnings, due diligence, assurance and tax services to search funds, private equity firms, and business owners and investors. The H&S Advisory team helps expedite a smooth, cost-effective transaction process that maximizes value and minimizes tax impacts for both buyers and sellers. To learn more about how Hood & Strong can support your M&A objectives, please contact Transaction Advisory Group Partner Jerry Zhou at [email protected].

Oberle Risk Strategies– Oberle is the leading specialty insurance brokerage catering to search funds and the broader ETA community, providing complimentary due diligence assessments of the target company’s commercial insurance and employee benefits programs. Over the past decade, August Felker and his team have engaged with hundreds of searchers to provide due diligence and ultimately place the most competitive insurance program at closing. Given August’s experience as a searcher himself, he and his team understand all that goes into buying a business and pride themselves on making the insurance portion of closing seamless and hassle-free.

If you are under LOI, please reach out to August to learn more about how Oberle can help with insurance due diligence at oberle-risk.com. Or reach out to August directly at [email protected].

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(00:00:00) – Intro

(00:03:13) – What are some high-level takeaways from the study?

(00:04:26) – Why has the number of investors declined?

(00:08:16) – Is there a formula for the ideal Searcher?

(00:09:49) – How much more prepared are Searchers today than 10 years ago?

(00:12:10) – What stood out to you regarding the number of LOIs and industries Searchers are looking at?

(00:16:47) – What are you looking to track regarding long-term holds?

(00:20:25) – How do you see entrepreneurs exiting holding companies?

(00:26:24) – Discussing the 2017-2020 cohort

(00:31:41) – Are there any changes in the questions you’re asked by students interested in Search?

(00:33:28) – The increase in women and minorities in Search

(00:35:00) – What do you hope to see in future studies?

Alex Bridgeman: I think a fun place to start would be talking about, first off, we’ve done this episode before for the previous study, which was a fun overview, but also a good primer for what the study is and the mission of the study. There’s lots of different observations you and I have been chatting about and emailing back and forth. But what’s your high-level impression of maybe high-level changes or things you’ve noticed? And then we can start diving into a couple of them throughout the study. And we can link to the study in the episode description so folks can easily find it too and follow along. 

Sara Heston: Mm-hmm. I think search is still growing. I think there’s more people doing it from different circles, different schools, different backgrounds. So that’s all good. I think returns are still good. I don’t think that we’ve seen a huge shift in the types of businesses. People are reverting back to more services business, but those have always been popular in search. So, it’s just a shift but not a huge fundamental change. I don’t think there’s any fundamental changes that have happened in search in terms of number of investors, it’s seen a slight decrease, or sizes of deals or multiples paid, like those are all very in line. There’s always nuance from year to year, but fundamentally, the key parameters of what search is are still very much intact. 

Alex Bridgeman: You mentioned that the number of investors was declining. What do you think is driving that? What’s behind that? 

Sara Heston: Yeah, I think searchers are figuring out that they have specific skill sets that they want in their cap table, and they’re building relationships with investors, and they’re determining that it’s easier to maybe wrangle 12 than it is 20, and so they’re picking those that really add the most value and are the most supportive and sticking with them and choosing to work with them. So, I think that’s driving some of it. There are a lot of investors out there. And so, it’s a bit hard for some searchers to narrow it down and pick, but I think they’re being really thoughtful now about who they put in their cap tables. 

Alex Bridgeman: Yeah, it’s a number of investors. The Stanford conference last year had, what, 180 investors, something like that. I remember counting, I think it was around 180. 

Sara Heston: Yeah, it’s a significant increase every two years, which is great to see. There’s a lot of capital coming into search. It makes it really hard to plan the conference because we’re running out of space. But it’s good for the industry as there’s more capital coming in, as long as investors understand what the core values and principles are of search and are there to support searchers. Because that’s a really important piece of what makes the whole model work. 

Alex Bridgeman: Yeah, and to your point around searchers being more selective, I noticed in the study, the average number of investors for a search fund went from 14 to 12. So there was a greater concentration on cap tables of searchers. I suspect part of that is just more institutional investors with more capital to deploy as part of that too. But it sounds like there’s kind of a couple of factors, like you mentioned being more selective on the searcher side for value add plus maybe more capital. Is there something else, a part of that equation that you think is driving that smaller number?

Sara Heston: Right, that as institutional investors are growing in number and in capital that they’re managing that they want larger parts of cap tables. But I also think that they’re able to offer more in terms of support for searchers. So, they don’t have to seek that from additional investors. I haven’t seen any other real trends or been able to find anything else at play which would account for the decrease from 14 to 12. But it is interesting to watch. I’m certainly open to other thoughts on that and have been asking around if anyone else had any other kind of insights on that because it is an interesting map. 

Alex Bridgeman: One thing we also talked about was the kind of acquisition rates finding kind of a medium or a baseline number that they’ve been hovering at for the last 10 years. You mentioned going back to the 2014 study that since 2014, acquisition rates have been pretty steady, even as the number of searchers has increased. That was pretty remarkable to see in my mind. 

Sara Heston: Yeah, the acquisition rate made a bit of a step change in 2014 to around 57% and has stayed pretty consistently around there, maybe up or down one or two percent a year. But it’s been pretty consistent, even as we’ve now seen a pretty significant jump in the number of searchers. The overall number over time tends to tick down because 57 is the new norm. But I would say, ’22 and ’23 searchers were not having a lower acquisition rate than those five or six years prior. 

Alex Bridgeman: How different do you think it is amongst searchers who are either much more maybe industry focused or having a different approach? If you could segment that large cohort of searchers out searching and will either find or not find an acquisition, how might you segment them to identify is there one group of searchers that’s having more success in acquiring versus another? Is there a way that you might segment? 

Sara Heston: We try to. So, we look at where you’re searching from, age, background, prior career, and nothing statistically significant comes out. Everybody wants to know the formula for the perfect searcher of this background with this age, who are focusing on this industry, all comes together. And it really, I think, comes down to just the individual and their unique mix of skills and traits. We’ve seen an uptick in the number of searchers that have taken ETA classes. And I think, I can’t say for sure yet if that increases the acquisition rate because we need to see in two or three years how that plays out, who acquires and who doesn’t, but that’s an interesting one I want to keep watching. Just, and that goes to the preparation coming in – how well they know the search model, how prepared they are when they’re launching – because that could have an impact on their success in making acquisitions. 

Alex Bridgeman: Yeah, you talked about how searchers today are generally much more prepared and have a lot more background information and knowledge on how search works and are a little bit more advanced in how far along they are in understanding search today than they were maybe 10 years ago. 

Sara Heston: Yeah, there’s a lot more information out there, a lot more research, a lot more classes and universities focused on ETA, and it’s great. It allows people to get different perspectives, learn lessons from the past. It really goes to what the search community is about, which is mentorship and support. And that proliferation of information and data being available to people has really enabled searchers to be more educated and get prepared. 

Alex Bridgeman: Yeah, even the, I was excited to see, as a non-MBA graduate, the non-MBA number hit a high of 24%, which is also pretty remarkable because when you also pair it with the number of searchers taking an ETA class in an MBA program also increased, that was an interesting pair of statistics to see both jump. 

Sara Heston: Yeah, it is. There have been a lot more classes added in the MBA programs, which I think accounts for that. But there’s just more resources out there, like this podcast. And many of the investors have a lot of great conferences and resources available on their website and are doing a better job of really preparing searchers. So, I think it’s easier for somebody without an MBA to get prepared to search. I do think there’s maybe a bit more of a hurdle there for them to just get dialed into the network and connected and make sure that they do have the full skill set that will make them successful. What the MBA does is it gives them some managerial skills. It’s not just learning how to search, but it’s learning some other skills as well as connecting with the network of broader searchers. And so, it’s probably a little bit bigger lift for someone without an MBA, but it is doable for people like yourself with the right background and motivation. 

Alex Bridgeman: Yeah, that’s pretty exciting to see. You had a couple of comments too about the number of LOIs and number of industries that searchers looked at and how the process was evolving. What stood out to you in kind of looking at that research and those numbers that came through? 

Sara Heston: Yeah, we reported a bit more detail on that this study, and I was excited that we have some good data to do that. So with regards to LOIs, the average time at which the first LOI was signed was 7.8 months into the search and we saw some as far as 18 months in when they were signing their first LOI. So, there’s a really wide range, which I want to share with searchers because I know that there can be some doldrums in the search stage of I’m behind the curve, or I’m ahead, or I’m struggling, to know that they’re- what the average is and that it is a wide range. And they signed 3.6 on average. So, there’s, unfortunately, a few false starts along the way too. So, search has its ups and downs, and the data really does prove that, that there is some challenges, but to stick with it because the first deal might not work, the second deal might not work, but the third and fourth might come through. And then in terms of industries, searchers are definitely taking a more deep dive approach and really understanding the industry, but they’re looking at a variety of industries. Those that made acquisitions in 2023 looked at over six different industries. So, they’re doing a deep dive, but they’re being open to pivoting and looking at other things or looking at things in parallel as they’re going through it. And then in terms of what industries, those that made the acquisitions in ’23 obviously aligned pretty closely with where we saw- the industries they were looking at aligned with the industries in which acquisitions were made. But we’ve seen a bit of the shift away from software, a bit more focus on services and tech-enabled services, which have always been a core focus of search. They’re just having a bit of a resurgence now. And if you look into those sectors, so dig down at the granular level, there’s not one very specific detailed industry within services that’s seeing a lot of deals being done. It’s really a wide range of businesses within services. 

Alex Bridgeman: On the software decline point, I was talking with a friend the other day and we were talking about a theory that perhaps some of the decline in software acquisitions is more so just a shift from search-related individuals buying software from the individual searchers buying it to more of the software consolidators who are operating with a search ethos or with a lot of similar search investors through consolidators who are buying software. Maybe the total number of software acquisitions is the same and still growing, but just who is doing them is changing. Do you think that has merit, or is there just something else going on or it’s just a natural ebb and flow of a market as cycles or industries come in and out of favor?

Sara Heston: I think that does have merit. And I think that’s played out in a few ways. It makes the bidding process more competitive. It drives up prices. It makes it harder for a searcher to gain traction, perhaps, with the seller. The area, the segment has become more competitive and that has probably resulted in fewer deals. It’s not that it’s a bad sector, it’s just gotten more popular as we’ve seen in other sectors over time and we continue to see. I’m sure you’ve talked about HVAC and how that’s gotten more popular too. And the private equity comes down and consolidators come in. It’s just that it’s more competitive for everybody. So, I think that’s what’s happening in a lot of the niches of software right now. And multiples are going up and competition has increased. And so searchers are looking for other opportunities. 

Alex Bridgeman: And on the point of holding companies and consolidators, you also put together a long-term hold, a couple pages as almost like we’re flagging that there’s a new area of study for the Stanford search study. What are some things you want to track through future years of that report? What kind of data would you be looking for? 

Sara Heston: Just to go back a little bit on the evolution of our focus on long-term hold, we first started looking at it in the last study in ’22 with just a note calling it out that this does exist. It’s been hard to define, and the definition continues to evolve. What we tried to do here was try to put some parameters around how a long-term hold might look different than a traditional search fund. Because our study only focuses on traditional search, the inclusion of some of these other strategies, as you can see in the report, we pulled some out that had previously been in, were skewing the data. They were making either much bigger deals or much smaller deals, and their capital flow was very different. And so, they didn’t fit in the box of core search. So, we wanted to take them out, but we didn’t want to ignore them because it’s a really interesting segment that’s growing and has a lot of the same principles as core search and overlaps with a lot of the same investors and a lot of the same types of individuals. So, what we’re trying to do is understand that these are different, try to figure out how to parse them, and then continue to track the long-term holds. What gets reported on them will depend a lot on how it evolves. We won’t report anything until we have a big enough end to report it out. What the 2024 or ‘26 study might report might just be numbers on the quantity over time, perhaps returns, but you have to give the long-term holds time to have returns. So, it’s how it evolves. Hopefully we can report maybe some details about how much capital they’re raising, how many investors they have, how that might differ from traditional search. It’s an interesting part of search that has emerged recently that we don’t think can be ignored. And so, we’re trying to wrap our heads around what it looks like and share with the community to really help educate people about this model that the term gets thrown around a lot and there’s a lot of questions about what that means and what that can look like.

Alex Bridgeman: Are there any personal questions of yours for long-term hold that you hope will be answered over the next five or ten years as some more of those kind of unique strategies play out? Is there anything that you’re like curious to see what happens over the coming years? 

Sara Heston: I’m interested to see how many start with the intent to be a long-term hold and end up playing out that way. So how many have a hold period that is longer than the normal six years of traditional search, how many end up buying multiple companies versus buying one that ends up being big and great and then they just kind of look like a regular search. So how the upfront intent actually looks different in the end than traditional search. It starts out different with the committed pool of capital, but I am really curious to see how they differentiate in terms of the types of businesses, how the companies look after 10 years, how they’ve morphed and evolved. That’s what I’m the most curious to see is how much this really, as it matures, looks similar to or quite different than search as we know it now. 

Alex Bridgeman: I’ll also be curious for how entrepreneurs decide to exit those opportunities, those holding companies, if they have built a portfolio of lots of different businesses, if they planned on it being a full career path for them for the next couple of decades, and then maybe 10 years in, they decide they actually want to do something else or shift around and how they get out of those. That’d be interesting to see. I’m sure there’ll be a handful that they just have a change of heart or decide to do something different, and how do they get out of those? That’ll be kind of interesting to see and how that plays out in a couple of circumstances. 

Sara Heston: Yeah, exactly. The upfront intent for 10 to 20 years is a long time and how much the reality matches the intention. 

Alex Bridgeman: Yeah, 20 years ago, I wanted to be a fighter pilot and here I am on a search podcast. So, who knows what’s going to happen? So that’ll be interesting to see. Kind of maybe going backwards and looking at previous cohorts, you had a lot of interesting thoughts around returns for different cohorts, both for those operating and those exiting. And one kind of interesting observation that I had that I want your thoughts on, if it’s valid or missing something, is when looking down the list of that diagram showing acquired, didn’t acquire, still operating, not operating anymore, and then by the MOIC multiples, it appears that, from my look at it, that the multiples are pretty correlated with a holding period, i.e., if you held closer to 10 years, your returns were better. Does that imply that if you run a business for longer, your return generally would be better? Or is there something around those searchers just found industries that lent themselves to building a more successful company, or it’s just kind of luck of the draw and they just found a great business that they decided to hold on to longer, and if you didn’t find a great business, you probably don’t want to run it for 10 years, so you sell sooner and thereby your MOIC is lower? Can you help me kind of understand those numbers a little bit more? I’m trying to decide if there’s any sort of concluding fact that we should take away from that information, or if there’s just too much kind of luck and randomness in it and there’s not a whole lot to take away from it. 

Sara Heston: I think there’s two things. One, in the early stages, returns are naturally lower. So, those that are currently, particularly those that are still operating that are one to two to three to four years in maybe are going to have lower returns. So naturally, the normal cycle, it takes some time for returns to increase. But when you look at the 10X that have exited, I think it was an average of 10 years that they were held, in many of those cases, they were really good businesses that were doing well and there was no incentive to exit. The CEOs were happy, they were executing, the investors were happy, and things were going well. There was a reason to continue to operate. And even if you look at those with greater than 10X returns that are still operating now, they’re on average I think it’s seven years that they’ve been operating. So those businesses are still going well and CEOs are aligned with investors still and everybody’s continuing on that path. I think if you were to look at some of the 5 to 10X that exited at five years, those had they held to 10 years, maybe 10X or greater than 10 Xers. They recapped or exited partway through their growth stage. And so, it’s hard to know. I know Will Thorndyke’s done a lot of research on that. And there’s a lot of thought about what if search investors held longer. The thing to remember on this is we are tracking returns from the investor’s perspective. So once there’s a recap, we put a pin in it and that’s the end of it. So, if the CEO stays and continues to go on, if the business is sold and they remain with the business, we don’t continue to track that. So once more than 50% of the company has been sold, then we consider it an exit. So, some of these businesses might actually go on to have much higher returns over time, but they exited at a certain stage in their growth. 

Alex Bridgeman: Would you be curious to see what those numbers would look like if you continued tracking it from the CEO’s standpoint? 

Sara Heston: For sure. It just gets very complicated to do that because… So, the way we are able to calculate a consistent return is the capital investors put into the company and the capital comes out. And then the CEO’s experience is quite different as they earn into their equity and then the recapitalization happens. It can be done, it’s just much more complicated. And then you need to have the buy-in of whoever the acquirer is to give you the data. I would love to see it all, but for private equity fund ABC who bought this business, they might not be interested in sharing with us their returns information. 

Alex Bridgeman: That’s understandable. I would not blame them for that. And for these returns, for the investor standpoint, you talked about earlier cohorts, like that 2017 cohort, supporting some underperformance from later cohorts. It was interesting to see, looking at the return numbers, that as search has grown, those returns have been fairly steady. In some cases, they have increased, even if you exclude the top five outcomes. I thought that was pretty interesting, but you had some interesting points around the 2017 cohort that it’d be fun to discuss. 

Sara Heston: Yeah, I think it’s the 2017 through 2020 cohort that started off really strong in their first few years and has stayed strong. So now they’re at least four years into operating or three years into operating and 44% have exited and they still have a 55% IRR. They’ve made solid acquisitions and some of our new greater than 10Xers were acquired in 2018, 2017. So that group has done really well. They’ve bought good businesses. They’ve executed well. The newer cohort, so just those that have purchased in the last two years, are off to a slightly slower start with about a 1.5 MOIC and I think it’s a little over 20% IRR, which isn’t necessarily a red flag. It’s just when you look back to some of the prior groups at this stage, they had slightly higher returns. But 2023 was generally economically a bad year. So, some of these companies were in their first year of operation. Most of them are all still operating, and we asked them to value their companies. So, I think what we’re getting is them saying, well, I paid seven times EBITDA, I’m just going to value it at seven times EBITDA. 2023 was an okay year, not a phenomenal year, so we’re just going to be conservative. So that could be coming into play here. But it is interesting that they are off to a bit of a slower start, so we’ll continue to see how that plays out. There’s still plenty of time for them to gain momentum. 

Alex Bridgeman: Do you have much visibility into what the drivers of those returns are for that ’17 to ’20 cohort that was outperforming? Was there a consistent theme of revenue growth or were add-on acquisitions a key part or maybe great interest rates contributed in some way? Like how much visibility do you have into where those returns were derived from? 

Sara Heston: I have some, not perfect visibility. I certainly would like more. And unfortunately, I haven’t come up with something. There’s still not a huge number. So, it’s hard to derive trends. They are in different industries. There wasn’t one specific industry that was doing better than others. Healthcare services has been a top performer and has slightly outperformed the group as a whole in a statistically significant way. So, some of those were in that industry and I think have been doing quite well. But overall, I’ve looked at acquisition prices. They weren’t making really big or really small acquisitions. They were buying things generally around the mean number of investors. Some did have more investors, so some had more than the like 18 to 20 range investors. So maybe that came into play, but again hard to know. Not enough to say, oh well, more investors definitely drove that because there were some that didn’t do well that had a lot of investors too. So, there’s nothing that statistically really jumps out as, yes, this was a trend working in their favor, other than maybe just a really good macroeconomic cycle for a while. 

Alex Bridgeman: That’s what kind of stands out to me reading through is how there’s not a ton of patterns to draw from. There’s not like one silver bullet that worked for everybody, there were examples all over the place of how returns came through or acquisition rates, backgrounds. There’s not a lot of correlation to find, like in the first episode that you, myself, and Peter Kelly did, we kind of talked about what is the perfect searcher and how a lot of folks ask you and there’s not a good answer. There’s not really an answer at all. And that’s just proving out again through this latest iteration. 

Sara Heston: Yeah, I wish there was more of that that was emerging, and we really dug in deep this time to try to find something statistically significant. I mentioned that certain industries were starting to see maybe outsized returns in the last couple of years as a possible interesting trend. So as our N increases, there will be the ability to dig deeper and parse things and get statistically significant identifiers. And hopefully, we’ll be able to have some more clarity on that. But as I said earlier on, too, and as we said back then, there isn’t maybe one perfect mix. It’s who people are. It’s how their cap table comes together in terms of supporting where they’re weaker and offsetting their strengths so that they are more successful in their search. There’re so many pieces that come into play that that’s what makes it hard. 

Alex Bridgeman: Are there any changes you’ve noticed in the kind of questions that students ask you when they’re thinking about search? Is there something that’s becoming maybe more top of mind for students or folks thinking about search? 

Sara Heston: I think searchers or students are much more prepared or knowledgeable on search. So, I used to have to explain really the basics of what a search fund was, and now they’re coming to me already knowing what that is. They’re already getting to school knowing what search is. It used to be that a lot would say, I heard people talking about this, what is a search fund, while they’re already in school, and now a lot more are coming in being clear on what a search is or having heard of it before. So, I think there’s just more knowledge out there about it. I think there’s also more understanding that a search can fit an individual and an individual doesn’t have to fit a specific model. I used to get questions of, well, I don’t want to move to Wichita, Kansas, and I don’t want to run a business that’s a service business. And that’s what search is and that’s what I’ll have to do. But I like the idea. And now search looks so different for each individual. And there are different models that fit different people that are all good. They have a lot of principles in common in what a good quality business is. And it can fit a bunch of different industries now. So, students are much more open to search can actually work for me and my personal place in life right now. And so that’s exciting to see. 

Alex Bridgeman: Yeah, that is exciting to see. What have we not covered that we should? 

Sara Heston: I don’t know if we touched on just the increase in the number of women in search and more minorities. And I think that kind of goes to what I was just touching on in terms of search doesn’t just have one model. People are starting to see how it can fit them personally. And I think the industry has done a really good job of not just highlighting that more work needed to be done, but then doing the work to be more inclusive and understanding about how the model can really work for different individuals and supporting that. And it’s starting to work. We’re starting to see that come through in the types of people who are searching. And I hope that that momentum continues. 

Alex Bridgeman: Yeah, that was amazing to see with the number of female searchers just going from 7 to 11 to 17% of searchers, even as the total number of searchers also increased. Because like the absolute number of growth must be just enormous. So that was really exciting to see. 

Sara Heston: It is. And we’re seeing more women solo searchers, women partnership searchers, and then male and female partnered searchers. So, we’re seeing a lot more mix out there in how they look, which is great. 

Alex Bridgeman: Yeah, that is great. That is exciting. Well, you’re not going to be involved in the 2026 Stanford search study. So, I’m sure Stanford will miss you and miss your contribution to that work. What do you want to see in future studies? What are you excited to see play out or see certain data points get added? What do you want to see in the future of the study? 

Sara Heston: Yeah, it’s fun to say that now since I don’t actually have to make it all happen. It’s actually hard to leave. I’ve really enjoyed working on this study and have a really deep-seated interest in it. I think this thread of long-term hold will be really interesting to continue to track and how that evolves. I’m actually kind of sad to be leaving at this stage when it’s getting really exciting. But I hope that that continues to grow. And then as the number of searchers increases, the circle is getting broader. There’s some perception out there that, oh, it’s skewed towards Stanford students. It certainly is not. And as the world of search grows, the study has to really work harder to encompass everybody. And that’s going to be fun to track, how searches start to look different as different ecosystems of- mini ecosystems within search continue to grow and evolve. So, I think that’s going to be fun to track. Do searches in Canada start to look different because there’s so much more search happening up there? And being able to drill down additional levels and identify trends like we talked about in terms of maybe an industry that’s doing better or a specific background or the growth of the business, to really parse out some of those things. Once you get a big enough sample size, you can start to have some good data to figure that out. 

Alex Bridgeman: Yeah, that’ll certainly be exciting. Well, Sara, thank you for sharing on the study for a second episode here. This has been a lot of fun. I always enjoy getting to hear and read through. And I didn’t really expect it to come through. So, it was super exciting to see that email pop through, and I downloaded it immediately. So thanks for putting it all together. It’s been a lot of fun to read and reference and send to folks who are curious about search. So thank you for all that work. 

Sara Heston: Oh, well, I’m happy to do it, but I do have to say a ton of credit goes to the whole search community. I really rely on investors and CEOs and searchers to get this done. Everybody pitches in, and I really do appreciate that. I’m just the consolidator of it. So it’s a whole community effort, and I hope that continues too because it really couldn’t be done without everybody caring about it and committing to it. 

Alex Bridgeman: Well, that’s certainly the spirit of search is very collaborative. So good to hear that that’s been very helpful to you. But thank you again for doing this. This has been a lot of fun. 

Sara Heston: Great. That’s good to see, Alex. And good luck with your search.