When folks ask what I want to be doing one day, I tell them I want to build a portfolio of small, private companies. But I’ve come to realize that statement doesn’t actually say anything. There are dozens of different ways to invest in small companies after all. An investor might acquire a small company directly and run it as the CEO. They could also invest in small companies they know in their local area or through searchers around the country. And while this wouldn’t count as private company investing, a micro-cap stock portfolio counts in my mind as a portfolio of small companies. There are many ways to be a small company investor, so which strategy, and its corresponding pros and cons, fits you best?
I want to discuss a few common options from least to most amount of personal involvement in the investments. The most hands off way, investing in small public companies, can be done by anyone at anytime so I won’t spend time on that one. I would say, and feel free to disagree, dear reader, the private equivalent of the strategy is being a search fund investor. As a search fund investor, day to day responsibilities within the portfolio companies are solved by the searcher who will be operating the business. Your role in the investment might only be a board seat or periodic check ins with the searcher and management team. Board and periodic mentor roles aside, a search portfolio might feel very similar to a public micro-cap portfolio.
There are two significant pros to this strategy. One, your time is more free compared to running the company yourself and two, you retain your geographic independence. If you’re like me and want to live in Bend, OR eventually, you can invest in searchers all over the country without needing to be in the same city as the company they’re running. This allows more optimization of personal life, hobbies, and family that is hard to discount.
The con though, which applies mainly to younger professionals, is you don’t get the same learning experience you would get from running the company. If you already have operating experience, or are getting it currently and investing in searchers alongside your CEO role, this doesn’t apply to you. But if you’re like me and don’t have this operating experience, investing in a searcher is a more limited learning opportunity. My thinking here is evolving, but at this stage in my life I’m trying to optimize for learning.
Then there’s the most hands on way, operating the company as the owner and CEO. And if a portfolio is the strategy, operate it until you feel confident hiring someone to fill your role and move on to the next company. This one has the least amount of geographic and personal time flexibility, but undoubtedly the highest learning and growth curve personally. (And likely financially too) The experience being an operator also compounds and the learnings can be applied to future portfolio companies and search investments, if that’s a strategy added later.
If you’re a younger professional like myself, the embedded question within this idea is, which is the right one to start with? Reading through this Twitter thread by Rich Jordan helped me think about this using the comparison of investing in real estate vs small companies. His analogy applies relatively cleanly to investing in search funds vs direct ownership and operation. Search fund investments are zero to low cash flow until greater appreciation down the road while direct ownership provides stronger cash flows to be reinvested faster. Rich concludes investing in small companies first grants more cash flow which after reinvesting can produce wealth faster.
I’m beginning to side with this line of thinking, but I still have a strong desire to invest in searchers over time and I believe they can be done simultaneously to some degree. There’s no reason I can’t acquire one or a few businesses over time and use those cash flows to invest in searchers. In fact, that might be the highest leverage way to achieve both outcomes. Start as an operator early to build experience with a long runway and use permanent capital from cash flows to make investments in other portfolio companies and search funds from a position of experience and financial strength.
Dear reader, what are your thoughts on where a young entrepreneur should start?
Think Like an Owner Sponsors
Live Oak Bank – Live Oak Bank is a seasoned SBA lender focused on search funds, independent sponsors, private equity firms, and individuals looking to acquire small companies. Live Oak has closed billions of dollars in SBA financing and is actively looking to help more small company investors across the country. If you are in the process of acquiring a company or thinking about starting a search, contact Live Oak directly to start a conversation at liveoakbank.com/contactus.
Hood & Strong, LLP – Hood & Strong is a CPA firm with a long history of working with search funds and private equity firms on diligence, assurance, tax services, and more. Hood & Strong is highly skilled in working with search funds, providing quality of earnings and due diligence services during the search, along with assurance and tax services post-acquisition. They offer a unique way to approach acquisition diligence and manage costs effectively. To learn more about how Hood & Strong can help your search, acquisition, and beyond, please email one of their partners Jerry Zhou at email@example.com.
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- Brent Beshore posed a question to Twitter about what could be improved within the search fund model, lots of interesting answers.
- This article by A.J. Wasserstein on advice for young MBAs heading out into the world really made me think hard about where I want to be in 10-30 years. Very good read if you’re in a contemplative mood.
- Kelie Morgan had a great thread about what she learned working at a dysfunctional company for 10 years.
- Taylor Pearson had this great thread about what guerrilla warfare, running a company, and my favorite sport, football, have in common. Great read.
- For you aviation geeks out there, here’s a great video about interesting airline routes that only exist/ed because of coronavirus, including the shortest commercial jet flight in the world from Eagle to Aspen in Colorado.
If you found an interesting article, podcast, or interview that I missed, please let me know, I’m always looking for interesting stuff.