I remember reading Walker Diebel’s Buy Then Build for the first time when I turned 27.
Until then, it had never occurred to me that you didn’t need to start a company from scratch to become an entrepreneur.
Rather, you could use other people’s money to buy profitable small businesses, with established product-market fit, and grow them.
In time, I’ve come to discover a vibrant ecosystem of aspiring entrepreneurs competing in this space.
For those of you who have explored this ecosystem, you’ll know it’s confusing.
Terms like “Searcher”, “Independent Sponsor”, “Private Equity” and “HoldCo” are used interchangeably to describe very similar things.
So in today’s newsletter, I want to explain the key differences between each of these labels, in layman’s terms.
My hope in doing so is that you’ll leave with clarity on the path that makes sense for you.
Be sure to read till the end — I have a quick announcement to make 🙂
Before we jump into the differences, let’s start with the core similarity:
All of these entities are business buyers.
They acquire profitable assets using a combination of debt and equity.
Usually in a change of control situation (ie. M&A) and often without strict industry criteria (though over time, certain firms do specialize).
So what falls outside of these bounds?
- Venture Capital - minority investors targeting hyper-growth companies.
- Strategic - corporate M&A teams looking for synergies.
- Family Office - generally investors; not direct buyers.
SMB Buyer Ecosystem:
A self-funded searcher is an individual (or small group) searching for a single business to buy and run as CEO.
The searcher gets an asset under LOI, borrows money from a bank and raises equity capital from investors to finance the deal.
The key term here is self-funded, which means the searcher is financing his own search process.
In other words, he works for free until a deal is consummated.
As a result, the searcher often retains a majority of the equity.
If the Search Fund model is new to you, start here.
In contrast to the self-funded model, a traditional searcher raises capital from investors before beginning their search process.
Once the capital is raised, they pay themselves a small salary (eg. $75k) and begin searching for the right business.
Generally, because investors are taking a risk that the searcher never finds a quality business worth buying, investors will expect a larger share of the equity.
To be fair, this certainly isn’t always the case.
Your ability to advocate for yourself and negotiate effectively will dictate how much of the economics you retain.
Search models are great, but limited to a single business.
An Independent Sponsor model is very similar to Traditional Search, except the Sponsor does not operate the business.
Instead, the Independent Sponsor acts as the connector of people and capital.
They find an asset, raise money to buy it, and hire a full-time CEO to lead it.
In return, they keep a small share of the equity and scale through repetition.
“Private equity is an alternative asset class where investors purchase shares in privately held companies”.
Isn’t that the same thing as every other model we’re discussing here?
But in this ecosystem, “Private Equity” is used to describe a firm that raises significant capital from investors to acquire large businesses with the goal of boosting near-term profits.
Investors expect to pay Private Equity firms 2% of assets under management and 20% of profits above a predetermined hurdle rate.
These economics are well understood by investors, but incentivize the Private Equity firm to raise big funds and exit quickly.
For everything else, there’s a Holding Company.
By definition, a HoldCo is an entity that owns a variety of unrelated businesses.
- It’s different from the Search model because it owns multiple assets.
- It’s different from the Independent Sponsor model because it retains most of the equity.
- It’s different from the Private Equity model because it has no pressure to sell quality assets.
In many ways, a Holding Company’s lack of definition creates an opportunity to innovate on traditional models.
In the past, I’ve written about the two businesses my partner and I have acquired over the past year.
We’ve learned a lot and are actively exploring the best way to scale our strategy by raising outside capital.
This exploration continues to point us back to the merits of the Holding Company approach.
If you’d like to receive updates on this journey, and potentially invest alongside us, please fill out this short 1-minute survey:
As always, my inbox is open.
See you next week,