REALLY Private Equity, with Royce Yudkoff and Rick Ruback – [Invest Like the Best, EP.33]

In this episode, I continue to pull on one of the most interesting threads that I have uncovered in the course of producing this podcast: the world of permanent equity.

My guests today are Royce Yudkoff and Rick Ruback, two Harvard Business School professors who have partnered to create a popular class that teaches students how to search for, acquire, and run a small business directly after graduation. The course is aimed at students who want hands-on, management experience as soon as possible. After purchase, there is no timetable for selling the business. Indeed, if done well, there is never any reason to sell because the free cash flow yields to owners are higher than most alternatives.

I approach this conversation from an investors standpoint. LP investors usually partner with these searchers to form what is called a search fund. A search fund allows recent MBA grads to spend time looking for a business and ultimately acquire it. The result is a small-scale but often high return proposition for investors.

I loved our discussion of what to look for in a business and what to avoid. The principles we list are useful for investors of any kind, and will particularly appeal to those from the buy and hold, value investing, and quality investing camps.

One point of note which wasn’t captured during the recording. One of the reasons this style of investing isn’t more well known that it is extremely costly upfront. It can take years to find a company, and once found, the transaction costs can be 20% of the total purchase price. Rick calls this category “REALLY private equity”

If you enjoy this conversation, be sure to check our Royce and Rick’s book. HBR Guide to Buying a Small Business, which goes into many of the topics we cover in even greater detail.


Show Notes

3:11 – (first question) – Explain the idea of a search fund and why recent MBA grads and LP investors would be interested.


5:26 – A look at the folks that tend to be most active in this space


7:53 – What is the scale of people involved in this


9:55 – Why it tends to remain among smaller investors and not attract larger hedge funds


10:57 – Is there any collectivization happening that are trying to muscle in


12:31 –  With a good example, they walk through the process of going through this


15:40 – Exploring the time horizon in these deals


17:41 – Getting into the idea of risk to these businesses


22:36 – The characteristics that people should screen for in these businesses

23:51 – Recurring customer bases

28:36 – Low cyclicality

30:04 – Low customer concentration (supplier concentration as well)

31:46 – Good free cash flow characteristics

32:05 – One that can be transferred away from the selling owner


34:04 – Recurring revenues vs repeating revenues


35:18 – What percentages of business hit these marks and qualify as good enough to be invested in


37:52 – The Castronics example and why you don’t want to be the most important provider to a large customer


42:15 – Looking at the entrepreneurs who get excited about this


44:15 – What are some red flags that you don’t like to see in these types of businesses

45:14 – Technology companies

45:55 – Companies that have stroke of pen risk

47:05 – Lifestyle businesses


48:23 – Why growth is not a massive priority in this arena


51:27 – What financing for these types of businesses is like

54:03 – SBA 7A financing


54:48 – How do you get involved in this if you have a check you want to write


58:58 – What is the incentive structure for someone running a searcher firm


1:01:22 – What was right and wrong about the traditional private equity world?


1:02:38 – What business would they want to own in perpetuity


1:09:05 – A quick look at margins in this space


1:09:34 – Looking at the most memorable individual day for each guest


1:12:36 – Kindest thing anyone has ever done for you


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