Holdcos

Originally posted to: chenmark.com/weekly-thoughts

When we came up with the idea for Chenmark while sitting around our dining room table back in 2014, we didn’t realize we were at the start of a huge wave of activity in the search/ETA space.? Fast-forward 10 years and ETA participation has exploded.? There are multiple?oversubscribed search fund classes at a growing number of business schools, a plethora of ETA boot camps and conferences, a highly active SMB twittersphere, and a growing number of search podcasts and WSJ profile articles.? Search has entered the zeitgeist, at?least as far as?the business school crowd is concerned.?

Back in 2014, we were not trying to be avant-garde, we just a) saw opportunity in being involved in the “silver tsunami” and b) thought that it made sense to buy small, cash-flowing businesses and reinvest those cash flows into buying more businesses, hence our “holding company” structure.? It turns out we are not alone in observing the appeal of this structure, and as part of the evolution in the ETA space, interest in “Holdcos” has increased in lockstep.?

To better understand these trends, we recently collaborated on a Yale School of Management note with our favorite professor. The note, titled Exploring Holding Companies in the Search Fund Ecosystem?does a deep dive into many factors driving interest in the space from both a searcher and investor perspective. The conclusion wraps it up nicely:?

“Holding companies are a fresh and innovative approach in the ETA community. The holding company label typically implies an entrepreneur who aims to engage in programmatic acquisitions and plans to run the vehicle for a few decades or indefinitely. There are many charming elements in holding companies that both entrepreneurs and investors are attracted to. Specifically, the ability to compound and grow capital for decades with tax deferrals presents an opportunity to concentrate on MOIC and create vast sums of equity dollars. However, these are not perfect or bulletproof mechanisms, and there are plenty of risks, like scaling disparate assets in far-flung geographies. Talent requirements are real at the field and holding unit levels and will require robust compensation that will challenge cash flow and likely dilute the promoter’s equity. Elite post-MBA aspiring entrepreneurs will continue to flood the holding company zone since they can raise tens of millions of dollars and live out their capital allocation fantasies. We hope entrepreneurs enter the fray for the right reasons and have grounded and realistic expectations about what a holding company sortie entails.”

From a Chenmark perspective, there are probably more pros than cons to increased participation in the space. So, when asked whether an aspiring Holdco participant should take the plunge, our best answer is...it depends.? Our best advice would be to follow the “half dozen pieces of advice for holding company entrepreneurs” from the SOM note:?

1. Do this for the right reasons
2. Embrace an operational mindset, especially for the early innings
3. Be parsimonious with equity capital?
4. Be wary of over-diversification
5. Understand that time is concurrently a friend and an enemy
6. Recognize twenty years is a long, long, time?

Amen. Good luck and Godspeed.?

Have a great week,?

Your Chenmark Team

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