Is The Juice Worth The Squeeze?
Big Deal Small Business, Issue #110
Is The Juice Worth The Squeeze?
Big Deal Small Business, Issue #110
A friend is planning to launch a self-funded search in 2025. We met through the newsletter a couple years ago — he’s helped me with my business operations, and I’ve helped him brainstorm through his career choice to launch into the small business ecosystem. We’ve stayed in touch, including him visiting my business in Seattle.
As he turns towards searching himself, we were chatting about my investing activity in search deals — obviously I intend to invest in whatever deal he surfaces. So far, I’ve invested in four search deals, one of which has exited and three are ongoing.
As we delved into self-funded search investing, we broached the concept of “is the juice worth the squeeze?”
In private equity, that question is actually asking the following: Does this deal have enough returns potential (in terms of dollar profit, not IRR) to be worth the effort?
If you run a $1 billion private equity fund, the traditional thought process is that you make ~10-15 investments of $65-$100 million each. That’s a reasonable number of portfolio companies to track and support without spreading yourself too thin.
So, imagine you find a really interesting deal — quirky, off-the-run, can buy it cheap. The catch is that it’s only $5 million of EBITDA — you can buy it for $25 million, which would be capitalized with $10 million equity and $15 million debt.
The issue here is that even if you deliver a 5x return, the total profits to the fund are only $40 million. By contrast, if you write a $100 million check and return a 2x, you generated $100 million in profit to the fund.
So although the 5x return is likely a more exciting deal, PE professionals are fond of saying “You can’t eat IRR.” In English, they are saying that their carry pool (profit participation in the fund) is ultimately a function of profit dollars — not IRR (annualized return %).
So the 2x returning $100 million deal contributes more profit dollars to the carry pool, even though it has a lower IRR (annualized return %). The 5x returning deal only contributes $40 million to the profit pool, even if it’s at a much higher IRR. Odds are, the smaller deal also requires more oversight & team time than the larger deal.
Long story short — even though the smaller deal may be a great deal, “the juice isn’t worth the squeeze” to a $1 billion PE fund. The opportunity cost of your time & focus is too high.
This isn’t just a theoretical conversation — I’ve been in the room having this exact conversation with investment committees many times over.
But how does that relate to ETA / small business investing?
When searchers are looking to raise equity capital for their deals, they also run into the issue of investors wanting bigger deals so they can write larger checks, for all the same reasons as a PE firm listed above.
In fact, it’s a well-known pattern in traditional search — traditional searchers find great deals, but they’re just too small to make sense for their investors.
In self-funded search, it’s even harder to write large investments. A $750K EBITDA business may translate to a $3.5 million deal size (including deal fees & working capital).
With an SBA 7(a) loan, the total equity need may only be $300K after the searcher puts in some equity themselves. An investor wanting to write even $100K minimum checks is going to struggle to get a full allocation in the self-funded search ecosystem.
This begs the question — why should an investor focus on self-funded search deals at all?
There’s the obvious answer — the small check sizes actually make sense for your personal investing strategy. This has been true for me. I’ve only wanted to write $10-15K checks anyway, which have been the smallest that self-funded searchers will accept. So self-funded search deals have just made sense for my allocation size.
But that doesn’t scale as hopefully your personal wealth scales. So why bother?
There’s a second answer, which is more relevant to my personal approach.
As I look at how I shape my working hours each week, I am putting more focus on doing work in relationship with others. I’m not looking to build things alone, I’m looking to build them in community and in connection with others.
This may seem obvious, but I only shifted focus after a dedicated period of self-reflection over the past several months.
Earlier this year, I worked with my executive coach on framing a personal vision document. This included the following components:
Vision Statement — A simple statement expressing who I want to be.
Core Values — The core values underpinning my personal vision.
Personal Mission — In order for my vision to be met, what does my life actually consist of.
Vision-Strategy-Implementation (VSI) Mapping — The strategies I will undertake to move closer to my vision.
While I won’t dive into the full personal vision document, there’s three core values that align most closely for me in search investing (and my broader work in the search ecosystem, such as writing this newsletter, speaking at SMBash, and organizing Seattle-area ETA events):
Connection: Deepening connection is an end in and of itself, and doing so requires two-sided vulnerability and commitment.
Curiosity: I need to be learning and experience new things & new people.
Shared Joy: I incorporate my people into my personal & professional initiatives to generate a sense of shared accomplishment & teamwork.
These three core values (out of five total) drive my approach to my participation in the ETA ecosystem.
Of note — as I re-read my core values, vision, and mission, I noted that there’s no explicit mention of investing. Investing is actually just a strategy for me to live out those core values in my day-to-day life.
Which brings me back to “is the juice worth the squeeze?”
My soon-to-be-searching friend was asking if there was a certain deal size or equity % below which I wouldn’t be interested in investing in his future deal.
As I thought about it…the answer was very clearly no.
I don’t have to make investment allocation decisions based on potential profit dollars. My hope is to make my own existing business generate enough profit dollars to meet my financial needs. (Also this newsletter…please consider subscribing to the paid version or sharing it with your friends!)
As a result, all of my search/ETA ecosystem activities, including investing, can be based on meeting my core values, not on profit dollars.
For me, “the juice” in search investing is in deepening Connection: backing a searcher I have a relationship with. It’s in supporting them through the intense journey of buying & operating a small business.
It’s in increasing my overall experiences of Shared Joy: celebrating with the searcher when they have successes & breakthroughs.
It’s in satisfying my Curiosity: learning about new industries, new working styles, and new approaches.
To be clear — I plan to make money along the way in my search investments. I don’t intend to make bad financial investments — I intend to counsel searchers I’m close with not to close bad deals.
So if the searcher is high conviction on a deal, and I’ve been sufficiently collaborative along the way, I feel confident that it’ll be both a good financial investment and personal time investment.
Even if the ultimate profit dollars are too small to move the needle for me personally, the juice will still have been worth the squeeze.
Looking ahead to 2025, I’m excited to allocate my time in accordance with my core values, personal vision & mission.
Hope you all have a restful holiday break & a happy new year — I’ll be in touch in 2025!
Thanks,
Guesswork Investing
P.S. If you’re interested in joining a Durable searcher peer group in 2025, they’re hosting a virtual happy hour for you to learn more. Link here!