What is the first thing that comes to mind when you hear entrepreneurship? For us, like many of you, it was the image of two or three guys in their twenties or thirties working on a tech startup in their garage. Often portrayed as daring, risk-takers and visionaries by Hollywood, entrepreneurs build businesses that transform the society against all odds with the investment from their Silicon Valley venture capitalist friends. The reality for most entrepreneurs is not that rosy. Entrepreneurship journey is a lonely road filled with ups and downs such as rejections from investors, challenges in finding product market fit to acquiring your first paying customer or securing funding that hopefully will pay off hefty returns in few years. This journey in its traditional sense is not suited for everyone and unsurprisingly not many decide to pursue this path. Luckily this is not the only way to become an entrepreneur!
If you take a course ‘Realizing Entrepreneurship Potential’ you will get familiar to a new concept of Entrepreneurship Through Acquisition (ETA). So, what is Entrepreneurship Through Acquisition? As name suggests it is a path to entrepreneurship by acquiring and growing an established small or medium sized business. ETA is typically pursued by an experienced professional later in their career after they gain operational experience and management skills. For these individuals with business skills, ETA can be more attractive than starting a completely new business from scratch in several ways.
- Firstly, the risk of failure is orders of magnitude less compared to a traditional entrepreneurship since you are acquiring an already established firm with paying customers, healthy balance sheet and operations history. Traditional startup spent countless hours of prototyping, customer interviews and experiment to carve out their market niche. Nonetheless large number of companies spent their time building an amazing product with no customers. You can skip all that by just buying an existing company. The reduced risk is attractive not only to entrepreneurs themselves but also to investors who would like to see returns on their investment.
- This brings us to the next benefit of ETA – access to financing. Financing is one of the most important and challenging facets of entrepreneurship. Unless you build a product that has paying customers from the beginning and able to bootstrap, you will need funding from investors. Even then most would like to have access to additional capital to fund their growth and expansion ambitions. There are tons of startups that fail at the idea stage due to lack of funding. For investors, the decision whether to invest or not relies on two simple questions. What is the probability of success for this startup? And what is the return on my investment? Obviously, if you are unproven business with no paying customers or even worse no functioning product, the chances of your success will be much lower. On the other hand, an established business with proven track record – main target of ETAs – will have much easier time finding investors.
- Capital is not the only thing that is essential in running a successful business. You may recall early giants like Yahoo!, MySpace who had tons of funding, momentum behind them but still failed to succeed or more accurately adjust to the ever-changing business landscape. Leadership and know-how are another important facet to a successful business. Business owners (sellers in our case) are quite often seasoned entrepreneurs close to retirement age in search of the next successor to take their business to the next level and continue their legacy. This means that owners are there to see you succeed and will mentor and guide you even after the acquisition is complete. Most, if not all, operators we have interviewed had very smooth transition process and still maintain friendly relationship with owners to this day.
We talked about what is ETA and why it is attractive to different parties. Let’s now summarize how a typical process looks like. ETA model is pretty standardized and can be divided into five main phases: preparation, fundraising, searching, transaction and operation.
- Preparation phase as the name suggests is doing the homework. It involves researching about ETA, meeting past searchers, investors, understanding pros and cons and then deciding whether ETA is something for you. It is a good way to network and learn more about the industry all while maintaining flexibility and not committing to a search.
- After the preparatory work and if you commit to ETA, then you start the next phase – fundraising. Fundraising involves drafting of Private Placement Memorandum (PPM) and then speaking to as many investors as you need until you close your funding round. PPM is a document that outlines your background, your motivation and investment thesis that investors can refer to. Typically, you need to raise enough funding to sustain the search process for two years. Most will have about a dozen investors in their cap table. It is highly recommended to have at least one investor in the geography that you will be searching, and often other investors will not invest until you find one. This is a model for a traditional fund, however some opt-into self-funded search. As name implies you fund the two-year expenses of search phase yourself then raise funds for acquisition after identifying an acquisition target.
- Once you have necessary capital to finance your expenses, you move onto searching. Searching involves identifying as many targets as you can through proprietary means or brokers and starting the conversation about the sale. Most searchers focus on a particular geography or industry when looking for potential opportunities. The idea behind the search phase is that you want to identify the right business at the right price. Although sounds simple, it is a gruesome process that takes a long time and requires bit of luck. Unfortunately, not all searchers manage to find a right company to acquire and close the fund after running out of money.
- After successfully identifying the target and completing the due diligence process, it is now time to finance the transaction. Most searchers keep their investors informed throughout the process, who usually then finance the purchase. It is also common to involve some sort of debt financing to complete the capital requirements from banks or other financial institutions. If an existing investor declines to fund the transaction, you have to raise additional capital from existing investors or other sources.
- Once the purchase is complete, you are now the new management of the acquired company. Usually business owners agree to three to six month transition period to help you learn about the business and develop relationships with employees, customers and suppliers. Now it is your time to run and grow the business to realize its full potential!
This model for entrepreneurship first began in the US in mid eighties and has been rising in popularity ever since. The above model is straightforward and has been replicated thousands of times successfully in the USA and recently in Europe. Search fund in the ETA is like Private Equity firms but target a niche that is too small and acquire only one business. Europe is an up-and-coming region for ETA and has all the attributes that can make it a successful market. Unlike the USA, European countries are known for their SMEs and family-owned businesses that are the prime target for ETAs. Moreover, Europe’s aging population mean that these business owners are close to retirement age and looking for their successors. Luckily highly educated population means there can be plenty of searchers that are fit to run these businesses. Lastly, European markets have access to cheap debt to finance business acquisition.
Hope this article piqued your interest in your entrepreneurship, especially ETA. If you are thinking of starting a search fund, we would like to share some personal qualities that will help you to become a successful searcher. While entrepreneurial mindset is critical for every CEO, it is paramount for searchers. There are many definitions of what an entrepreneurial mindset really is online but in essence it is the way one thinks and approaches goals and challenges, to keep iterating and create solutions to problems both big and small. Throughout your journey as searcher and operator you will face many obstacles and rejections. You cannot get discouraged; you should expect these setbacks! Embracing and learning from failure is core to any successful venture but especially so for searchers, who will need the resilience to overcome years of searching for both targets and investors – almost entirely on their own. Building trust with owner/sellers (often decades your senior), swaying investors, negotiating the purchase and leading a team, especially without a venture yet in place, demands strong empathy, collaboration and communication. Not to mention humility. These qualities are the secret sauce to any successful searcher. Given the closely held nature of most searchers’ targets, it is no surprise that the human touch is one of the most valuable assets a searcher can have.
Search Sherpas
INSEAD SUMMER STARTUP TOUR 
Leave a Reply