Why do talented, future CEOs choose to pursue a partnered search?
Attend a search conference or listen to a panel of search experts and you are bound to hear some variation of the long-held conventional wisdom about partners in the ETA community. The general premise never changes:
Search is a tough, lonely road and partnering with a fellow MBA makes the endeavor less daunting. Having a partner will allow you to cover more ground, faster. Two searchers can manage more interns, talk to more owners and make more offers. Besides, two heads are better than one!
The underlying logic is alluring for current MBA students or recent graduates from top business schools since they are ideally placed to find a partner. Teaming up with a classmate seems like a natural choice since each partner knows the other’s strengths and weaknesses. Plus, searching and being a CEO can be pretty lonely, so having a co-pilot sounds great.
What’s more, a cursory reading of the 2018 Stanford Search Fund Study seems to endorse the partner track. Roughly 50% of traditional funds are partnered searches and partners are equally likely to acquire a company as solo searchers. Unfortunately, that’s where the study becomes murky. The study’s authors write that partnered searches have “a higher likelihood of acquiring a company and achieving a higher than 5x outcome, although this does not imply causation.” This acknowledgment should lead an astute reader to pause and ask, “Does pursing a partnered search actually make sense?”
LET’S CONSIDER THE ECONOMIC IMPACT OF THE CHOICE FROM THE PERSPECTIVE OF A SEARCHER:
If you buy a company with a partner, your equity stake in the deal just dropped from 25% as a solo searcher to 15% as part of a duo. Instantaneously, you gave up 40% of your equity! That is an expensive price to pay given that partnering exposes you to a set of underappreciated financial and operational realities that negatively impact your outcome in the traditional search model. Consider the following:
You will need to raise more search capital to support you and your partner
That extra search capital will be subject to a 50% step-up at close
You will have a big incentive to buy a larger company that can:
Provide meaningful roles for you and your partner
Sustain two MBA salaries
In order buy a larger business, you will have to pay a higher entry multiple…probably in the 6-8x EBITDA range.
You will have to raise more investor equity to finance the transaction
That investor equity typically commands an 8% preferred return
At exit, your upside from multiple expansion will be limited, diminishing the value you capture from growing your company
Buying a company at high multiples exposes you to the risk of multiple contraction if the economy declines
And finally, when investors put in large equity checks, poor performance by first-time CEOs can more easily result in their removal, as witnessed in a growing number of recent deals.
The cumulative effect of these tradeoffs makes it exceedingly difficult for you to earn the third tranche of equity in your company. Thus, you and your partner will likely only split 20% of the equity upside in your deal. That’s 10% for you.
When you add the possibility of divorce risk to the equation, partnered search is even less attractive. What are the odds that you and your partner eventually disagree about the search process or what company to buy? What if your partner has a spouse or significant other whose commitment to search wavers? Lastly, who will be the CEO? Will you be co-CEOs? The list of questions goes on…
Finally, when you choose your partner, you have no idea what company you will buy or how strong a management team you will inherit. If you do need an additional senior manager, would you really hire your partner? Wouldn’t it make more sense to recruit an executive with 10-15 years of industry experience and pay them a six-figure salary with a bonus…and no equity?
If you are still think taking on a partner makes sense, build a simple financial model. The decision to search is likely the most important professional decision in your life thus far. So do the math!