ETA: A Practical Approach to Business Ownership

How Acquiring an Existing Business Offers a Smart Alternative to Startups In a 3-Minute Read

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The Gist

With an estimated $72 trillion in business ownership transitioning in the coming years, Entrepreneurship Through Acquisition (ETA) presents a compelling path for aspiring entrepreneurs.

What Needs to be Understood:

• Defining ETA: ETA is when you focus on acquiring and operating an existing, cash flowing business rather than launching a new venture from 0 to 1.

• Historical Context: The concept of the "search fund" formalized in 1984 by Harvard Business School's Irv Grousbeck, offering a structured pathway for MBA graduates to identify, acquire, manage, and grow a privately held company.

• There Are Many Models

  • Traditional Search Fund: This model involves raising capital from investors across two phases: initial funding for the search process and subsequent capital for the acquisition itself.

  • Self-Funded Search: You’ll utilize your personal capital to finance the search for an acquisition target. This approach gives you control, freedom, and equity ownership but requires a higher degree of personal financial risk tolerance. Acquisition financing may still involve external debt or seller financing.

  • Sponsored Search: You’ll partner with a single investment firm, typically a family office, which provides all necessary capital for both the search and the acquisition.

  • Incubated Search: A relatively newer model where you’ll join an established incubator platform specializing in search fund investments.

• The ETA Process

  • Phase 1: Search Fund Formation (2-4 months)

    • For traditional models, this involves investor outreach, developing a compelling investment thesis, and securing initial capital commitments.

    • Key Activities and Deliverables:

      • Create Private Placement Memorandum (PPM) and investment thesis

      • Network and pitch to potential investors

      • Secure investor commitments

      • Complete legal fund formation

  • Phase 2: Opportunity Sourcing and Evaluation (1-24 months)

    • A systematic process of identifying potential acquisition targets, conducting due diligence, and assessing their financial and operational viability.

    • Key Activities and Deliverables:

      • Build and execute systematic outreach strategy

      • Screen opportunities against investment criteria

      • Conduct preliminary due diligence

      • Build relationships with business owners

  • Phase 3: Transaction Financing and Closing (2-6 months)

    • Securing the necessary financing for the acquisition, negotiating final terms, and completing the legal and administrative processes to finalize the deal.

    • Key Activities and Deliverables:

      • Negotiate and execute Letter of Intent (LOI)

      • Complete comprehensive due diligence

      • Secure transaction financing

      • Execute purchase agreement and closing

  • Phase 4: Business Operations (4-8 years)

    • Assuming leadership and operational control of the acquired business, focusing on growth, efficiency improvements, and value creation.

    • Key Activities and Deliverables:

      • Execute owner transition and 100-day plan

      • Build/strengthen management team

      • Implement key strategic initiatives

      • Establish effective board governance

  • Phase 5: Exit Strategy (4-6 months)

    • Executing a sale of the business to realize a return on investment for both the entrepreneur and investors (if applicable).

      • Determine optimal exit timing and strategy

      • Prepare business for sale

      • Engage with potential buyers

      • Execute final transaction

Observations:

• Historically an MBA Has Been The Pathway: The search fund ecosystem has historically been heavily populated by graduates from top MBA programs.

• Small Businesses Are Important: Accounting for 44% of all economic activity and employing 46% of private workforces.

• The Returns Aren’t Bad: Search funds generate, on average, a 33% IRR and a 5.5x multiple on invested capital.

• An Average Search Fund Takes: Approximately 19 months to find and acquire a company.

• The Average Starting Capital of a Search Fund: Approximately $426,000

• Ideal Target Business Profile:

  • Financial Characteristics

    • Valuation: $5-30 million

    • EBITDA: $1.5-5 million annually

    • Strong, stable cash flows

    • Healthy balance sheet with manageable debt

  • Business Attributes

    • Industries: Manufacturing, distribution, business services, healthcare, technology

    • Growth potential through operational improvements or market expansion

    • Strong market position within defined geography

    • Established business model with proven profitability

    • Opportunity for management transition (often retiring owner)

  • Strategic Considerations

    • Majority/full control acquisition preferred

    • Clear opportunities for value creation

    • Potential for operational improvements

    • Defined exit path within 5-10 years

Something to Think About:

• How much risk are you comfortable with?

• To what extent are you willing and able to deploy your own capital in pursuing an acquisition?

• What level of ownership is your target?

• How much day-to-day involvement do you want in the business you are seeking?

• What level of external support, mentorship, and infrastructure do you perceive as necessary for your success in this endeavor?

Insights from Chicago Booth:

The Search Fund Basics From Stanford:

An MBA Favorite:

SBA 7(a) loans:

Seller’s Note: