Rick Ruback:

On today’s episode of Think Big, Buy Small, we feature two former students of ours who are contemplating the decision of whether to look for a small business to buy and run or to pursue a more traditional post-MBA career path. 

Royce Yudkoff:

The decision of whether to pursue an entrepreneurship through acquisition path is at the core of our podcast. It’s a tough decision to eschew the more well-traveled career paths to instead take a chance on yourself and on your ability to find an enduringly profitable small business, and at a good price. Still, through our years of teaching and researching entrepreneurship through acquisition at Harvard Business School, we’ve seen many former students – and others – discover this path to be an intriguing and rewarding alternative to a more traditional job or to starting a new company from scratch. 

Rick Ruback:

Ari Santos and Allan Newman both served in the US Army, both graduated from the Harvard Business School, and both are married. Though there are parallels to be made between their personal and professional paths, as our listeners will learn, these similarities in their backgrounds make their differences all the more interesting and nuanced.

Royce Yudkoff:

That’s right, Rick. Listeners should also keep in mind that these conversations were recorded in April 2024, just a few weeks before our two guests were scheduled to graduate from Harvard Business School. So, without further ado, let’s begin by meeting our guests, starting with Ari Santos. 

Rick Ruback:

Ari, get us started. Tell us about the journey that brought you to this moment in your life. What did your parents do? Where did you grow up? That kind of stuff.

Ari Santos:

So, I'm originally from Miami, Florida. I would say we were squarely middle class. My dad works for the City of Miami. My mom worked for an architecture firm. I grew up the middle of three brothers. Baseball was huge. My older brother went to the Naval Academy and then, when I turned 18, I'm like, "I have no idea what I want to do." So, I ended up joining the Army. I went to West Point. Once I graduated, I commissioned as an infantry officer, did five years in the Army, and I figured it was time for me to move on. It was really a matter of family considerations. I had just got married. I spent five years in the army, a lot of that was away in Poland, in Kuwait.

I wanted to settle down, start a family. The Army's tough on families, moving every two, three years. You don't really have a lot of agency over where you go and what you do. Came here to Harvard Business School wanting to do something entrepreneurial but I was really looking into tech startups, mostly because I had no idea what search was. Really, my first experience in search was your class, Financial Management of Smaller Firms, and it opened my eyes to a different side of entrepreneurship. Last summer, I interned at a tech startup called Astro Forge. It's an asteroid mining company out of California.

Rick Ruback:

You weren't flying in an airplane to find...

Ari Santos:

I was not in space mining asteroids. I was in California doing PowerPoint, Excel, typical business stuff. It was a cool experience but I remember being in the middle of it like, "I don't know if this is really for me." I miss that leadership management component of the Army. That's what generally interests me in search. And I graduate next month. I’m not exactly sure what I'll be doing. I do have some options on the table and search is one of them.

Royce Yudkoff:

And now let’s have Allan Newman introduce himself…

Allan Newman:

I grew up in Minnesota, suburb of the Twin Cities. Dad was a consultant and mom was a homemaker, raising me, my brother, and my sister. I went to West Point. Choosing to go to West Point, I think the number one reason was character development. And I was choosing between three branches, Navy ROTC, Air Force Academy, and West Point. I think there's great character development in all three but I was advised to go to the Army because it's all about the people. So eventually I flew helicopters, but it's still much more about the people. And that was from day one. That's emphasized again and again. And I didn't really know at that time how much that would resonate with me and how much I still look forward to that in the future, that the people are the number one piece of what I will prioritize on what paths I take. And I chose aviation because I thought there was a good personal interest plus personality mix in that branch. And at that point you sign an eight-year contract for flight school and then to serve afterwards. And then the decision to leave is control over life, because they're going to move you every two to three years. You have a little bit of options but you don't really. Also, my wife was a classic underemployed spouse. So, by having more stability and getting out, we can now have her pursue her path as well.

Royce Yudkoff:

Any kids, Allan? You guys have a family yet?

Allan Newman:

No kids, also because we never felt stable enough. Lots of people do and they do very impressive in moving that family around, but we just didn't feel like it was the time.

Royce Yudkoff:

Let’s now turn to the search decision by looking at the alternatives that both Ari and Allan are considering. First we’ll hear from Ari.

Ari Santos:

I think it's still in the tech startup space. I like working in smaller teams. I like where my work has some impact. I imagine if I went somewhere corporate or something like investment banking, consulting, my work gets drowned out. I wouldn't feel like I have a sense of agency and that's the reason I got out of the military in the first place. So, I would see myself getting back to early-stage tech, call it seed, series A, something like that.

Rick Ruback:

Now we’ll hear Allan’s thoughts on what his alternatives to search might be.

Allan Newman:

I think a very good fit is PE operations. I think it connects well with veterans, and the hesitation there though is that they're probably going to send you to where they need you. I want to choose where I want to live because I haven't chosen for the last eight years. So, either that or general management. I was looking at leadership development programs. I see that as very similar to the Army, rotate around all the functions, get to learn everything, and then hopefully go be a general manager. I think that fits well for me too, but also similarly, that organization would move me, potentially without my full choice.

Rick Ruback:

At first, these alternatives seem so different: a vague, highly uncertain tech startup versus operations in an established business, perhaps owned by a private equity firm. However, when you do more than scratch the surface and look at why they are considering these career paths, some interesting commonalities emerge. Let’s hear some more on this topic from Allan.

Royce Yudkoff:

So, a big part of this is wanting to have control over where you and your wife live.

Allan Newman:

Huge, absolutely. Control, yup.

Rick Ruback:

And it's not just control over where you live.

Allan Newman:

Well, right. Live and lifestyle. And a big part of this to me is I think I'm very good at choosing what to spend time on and although I'm sure customers start choosing how you're going to spend your time, I think that also fits very well with entrepreneurship. Am I going to spend Monday morning doing something not work, but then I'm going to work the weekend? I'm very happy to do that. I'm very happy to spend time as needed where I think it's best. So, control over time as well.

Royce Yudkoff:

Well, generally when you own your own business, it's not so much that you work less hard than in working for someone else's company. You probably work more hard, on average, but as CEO you get to pick a lot of the times when you do and don't work, right? No one is going to say “no” when you leave at 3:00 to make a commitment with your wife. And if you want to work from 9:00 PM to midnight that evening, that's fine too. You get to choose “when” more than someone in someone else's company does.

Allan Newman:

Right, and that's a trade-off I'm very happy to make.

Rick Ruback:

Even on the long hours, they're fulfilling because they're hours that you're picking what you do and you've decided it's important. It's the long hours doing something that somebody else thinks important that you don't really think important is painful.

Royce Yudkoff:

For sure, that's one of the big differences between being a CEO entrepreneur and working in a large organization. In a large organization, someone’s telling you do A, then B, then C, or hit this sales target. And when you're a CEO, your first job is assembling your own to-do list for the day. That's something you always say, Rick.

Rick Ruback:

Right. I always say that the most challenging part of being a CEO is you have to assemble your own to-do list. You wake up in the morning and say, this is what I think is important for me to do. And if you work for somebody else, they give you that to-do list. I bet the Army didn't ask you what you thought you should do, right? They probably told you what to do, "Fix that airplane. Fly that airplane."

Allan Newman:

Well, impressively, they give you actually a lot of autonomy. They give you left and right limits. And I didn't realize how much autonomy I had until I went to investment banking this last summer and I realized how little autonomy is possible in a role.

Rick Ruback:

I love it! What you're saying is in a financial professional service role, you had less autonomy than you had in the US Army.

Allan Newman:

Absolutely. It's counterintuitive and it surprised me very much. But in the Army, I got my task, go out and do it, figure it out. Am I going to go talk to people? Am I going to create a little plan and then talk to people? There are some opposite scenarios where also you're told to sit in an auditorium for eight hours a day for five days straight. But generally, as a leader in the Army, once you're a lieutenant and beyond, you figure it out and you reap the rewards or punishment of spending that time well.

Royce Yudkoff:

Yeah, I can see why there'd be a lot more autonomy than say in a large professional service organization, where each task is being very specifically described and inspected, and you don't have a lot of autonomy compared to that.

Allan Newman:

Right. The mission command theory of the Army, they push everything down as far as you can because that person on the ground, the lowest level leader knows the most and can probably accomplish it the best. Yeah, and I enjoy that part.

Royce Yudkoff:

Like Allan, Ari is also focused on a career that gives him some control over what he works on, when he works, and where. On the same topic, here are Ari’s thoughts.

Ari Santos:

I would love generally to be the boss. I think in the Army, you have agency within your left and right limits, and as soon as you get out of there, someone's going to hammer you back in. But yeah, that plays a huge role for me and it was the reason I was interested in entrepreneurship from the very beginning. And if I'm not the "boss" right away, I'd still love to be in a small team working directly with the boss, with the leadership. That sounds exciting to me. Just a contributing member of a large organization is not something I was really ever interested in doing, leaving the Army and coming here. So, I was always tilted towards something entrepreneurial. I think a joiner in an early tech company, it would almost certainly have to be a joiner, because I have zero coding, like zero technical experience at all. But that does play a large role for me.

Rick Ruback:

I'm really intrigued by this tech startup thing because it just doesn't seem to fit you very well. You're not a techie guy, are you?

Ari Santos:

No, no, I'm not.

Royce Yudkoff:

There are no blue-collar workers in a tech startup.

Ari Santos:

It's a total 180 to go from asteroid mining to HVAC or whatever. I do get that. It's more the environment of “it's exciting, you're working towards something bigger, it's a small team, your work has impact.” It's more that, and then, “Okay, what's the avenue to achieve that?” It’s the way I was thinking about it. And to your point, I was working at a tech startup and about a month in, I'm just like, "I'm just staring at a computer screen all day." Can't say I loved it.

Royce Yudkoff:

Right, because it might be a small company where things are happening, but if your role is a very narrowly scoped analytic role, you're not really making decisions.

Ari Santos:

Correct.

Rick Ruback:

Well, it's not just decisions. Ari's really a doer. He wants to come home with dirty fingernails, and it's hard to do that at a tech startup.

Ari Santos:

Yeah, exactly. But that weird itch you need to scratch as you get out of the Army and you miss being with the guys and getting your hands dirty, I don't think that really exists outside of search. If I knocked on the nearest auto mechanic shop, they'd probably be like, "Get out of here. You have a Harvard degree. Like, what do you want? Get out of here." So yeah, I don't think there's an avenue for me to scratch that itch besides search. And early-stage kind of gets after it but kind of doesn't, because I did it and I was doing financial modeling, I was doing sales, and I was doing investor relations slide decks.

Royce Yudkoff:

Feels very similar to a job that you would have in a very large company, frankly.

Ari Santos:

Yes, with pizza and you get to wear a T-shirt, I suppose.

Royce Yudkoff:

Yeah, those are pluses for sure.

Rick Ruback:

That's coming to large companies too.

Rick Ruback:

So, for both Allan and Ari, it’s about control over the what, where, and when of work. They have different approaches to thinking about potential solutions, but they are focused on the same underlying problem.

Royce Yudkoff:

Do you think this desire for control and autonomy is a response to their time in the Army, is it generational, or is it just who they are as humans?

Rick Ruback:

It’s probably a bit of all three. I’ll add one more: people rationally gravitate to jobs that they have the skills to excel in. These two guys are natural leaders, and those leadership skills were nurtured in the Army. Both seem to intuitively know that their future is leading people and those are the careers they’ll pursue if they don’t search. I’m not interested in being a point guard in the NBA – I know I’m too slow, too old, too clumsy and basically have none of the skills to excel there. However, I do have a creative mind and that serves me well as a professor. We all need to find our place, and I think these guys are on the journey to find theirs.

Royce Yudkoff:

And what seems clear is that both could find a small business to run as CEO that would fulfill this desire for autonomy. In fact, I’d bet that it would be much easier to find a company to buy than to find a traditional post-MBA job that would pay them a competitive wage and give them the control and leadership opportunities that they’re looking for.

Rick Ruback:

I agree, Royce. Now, let’s hear from Allan about his ideal business to own and run as a CEO.

Allan Newman:

Yeah. There's the values of the business, like financial values, recurring revenue, and all that. But I think of it more as in, “Who am I going to work with on the day to day? Who am I solving problems with together? Am I getting phone calls late at night or more of what are the problems with those phone calls?” So, I don't really have a great answer for that. I feel like it's kind of like you know when you see it. Like I'm not really interested potentially in construction, but I've been looking at a bakery and that excites me for the aspects of producing a physical object with a team and almost the light manufacturing aspects of it too, and operational efficiencies, along with some artistic part of the product that's being produced.

Rick Ruback:

Do you imagine getting dirty at work?

Allan Newman:

Yes. So, I used to think I'm ready for the office job after the Army but then I had that experience and I would like to be outside or travel...not traveling like flying across the country, but like going across to different locations or job sites, things like that. So yes, I want to get my hands dirty in that regard. I think I'm very flexible, in general. I care much more about who are the people I'm with - suppliers, customers, and employees - and how are we solving problems together?

Rick Ruback:

You want to be connected to whatever the product is.

Allan Newman:

Right, I want to feel like I can contribute, yeah, I'm not going to be that expert in the room, but I want to help solve problems for our customers.

Royce Yudkoff:

So, I guess a lot of entrepreneurs through acquisition that we meet, you're kind of broadly agnostic about the type of business it is. It's really about managing a team of people, getting the product out, making sure things work well, kind of the management itself more than the product. Is that...

Allan Newman:

Right. Which maybe is too generic and maybe I have some more thinking to do, but I think that's also when you're looking at these organizations, I can look at each one objectively.

Royce Yudkoff:

And I think it opens up a broad set of choices for you, right, because you're looking for an enduringly profitable, quality business in a place you want to live, and you've chosen not to bound yourself by a specific product or service.

Rick Ruback:

Yeah. I think you can only pick one dimension on which to restrict yourself. So, if you're going to restrict yourself in geography, I think you have to be pretty open with respect to industry. If you're going to restrict yourself on industry, I think you have to be pretty open with respect to geography. One or the other. You need to make sure there's a big enough opportunity set to be successful and so you don't want to slice that too narrowly.

Allan Newman:

Yep.

Rick Ruback:

Ari has a different ideal business to own and run as CEO but, like Allan, acquiring a company that provides more blue-collar products or services is a key attribute he’s on the lookout for. And here’s how Ari tells it…

Ari Santos:

I just like the technicians-in-a-truck-style businesses because that's what I was used to in the Army. So, in the Army, I was leading teams of forty, a rifle platoon and then a distribution platoon. And yeah, I'm comfortable with the blue-collar environment, logistics heavy. I'm more comfortable leading a team like that than an accounting team. I don't think I'd even know where to start leading CPAs or something like that. So, if I were to search, I would definitely lead in the blue- collar services broadly. And then not to mention they have a lot of the good characteristics of contractual revenue, their essential services, non-cyclical, things like that, the things that you look for in a stable, enduringly profitable business.

Royce Yudkoff:

But the number one thing feels like it's something you've done before. It feels like running a platoon again.

Ari Santos:

100%. I would feel comfortable. I can be myself and mess around with the guys and they'll poke jabs at me and I'm totally comfortable in an environment like that.

Royce Yudkoff:

That's really helpful. So, I mean that's like a great thing because there are many more of those. And the pricing, as you said, is usually much better because lots of people don't feel comfortable supervising blue-collar workers.

Ari Santos:

Right. I feel uncomfortable wearing a suit and tie.

Royce Yudkoff:

Both Ari and Allan seem well-suited to looking for a business to own and run, and both are inclined to look for blue-collar businesses where the multiples are typically favorable and there are numerous available targets, many of which are enduringly profitable businesses. It seems that searching is such an obvious choice. Given all of this, it’s reasonable to ask the question: what, if anything, is stopping them? 

Rick Ruback:

Location, location, location – and family considerations! Both Allan and Ari have strong geographical preferences that have a huge impact on their decision-making. For Allan, his wife’s career path is in the forefront of his mind, in terms of thinking about where to search. Let’s hear more. 

Royce Yudkoff:

So, it sounds like one of the things you'll be dealing with is, if you buy a business, where's that going to be located and how does that also fit with your wife's interest in a career?

Allan Newman:

Right.

Rick Ruback:

What is her path?

Allan Newman:

So, she actually works here at HBS right now, and then she’s just gotten into Harvard Graduate School of Education. So, she'll be doing that program for the next two years, and onwards and upwards from there.

Rick Ruback:

Interesting.

Royce Yudkoff:

So, does that mean that you will need to be based out of Boston for the next couple of years?

Allan Newman:

Yes. I'll be looking in the Boston area.

Rick Ruback:

And here’s Ari, sharing his thoughts on where he’d like to search…

Royce Yudkoff:

We'd love to hear a little bit about the pros and cons you see in buying a small business, because you're right in the process of being thoughtful about it now. And I think all our listeners would like to know what the considerations are for you. So, let's start with some buckets of concern that Rick and I hear all the time, like family life. How are considerations about your family dovetailing with the idea of search versus the idea of getting a job in someone else's company?

Ari Santos:

I have a one-year-old son. He's toddling, he’s starting to stand on his own. He is 13 months and that obviously plays a huge role. There's a huge deciding factor in what I end up doing, where we end up going. Ideally, we want to stay close to family. It's kind of weird being isolated - just me, my wife, and my son, with all my family, they're back in Texas or Florida. So, yeah, that definitely plays a role in what I do afterwards.

Rick Ruback:

So, your hope is to end up in either Miami or...

Ari Santos:

I hope so.

Rick Ruback:

Where's your wife from in Texas?

Ari Santos:

El Paso, way west Texas. Geographic uncertainty plays a big role. Truthfully, I think that's the major one. If I were to start a search, so you move to conduct a search or perhaps stay in Boston, and then two years later you find a business. You don't know where it's going to be and you move there. And there's uncertainty about where you're going and what you're doing. It kind of strikes a similar vein to the Army. You have a little bit more agency, I would say, but that uncertainty is the reason I got out of the military.

Royce Yudkoff:

Well, you have a little more agency because when you look at that information document on the company you might buy you're alone in your office and you can decide, "Am I moving or am I not?" And no one's going to second-guess that decision. In the Army, I'm guessing you can't do that.

Ari Santos:

You cannot do that.

Rick Ruback:

You can't decide which crises fit your geographical taste. You can't say, "You know, I really feel like being in the sun. So, could we have a crisis, say, in the Middle East?" or "I feel like the cold so I could go to Afghanistan and ski?" You don't get those choices.

Ari Santos:

Yes, that is true. There's a second consideration. I feel like they feed into each other, which is the immediate financial. I feel like if I did raise a search fund, would I be able to say “no”? I feel like I have an obligation to the investors that provided the search capital to be like, "This is good business. I know it's in the middle of nowhere and my family's not going to like it, but okay, I'm going to do it." But yeah, the second consideration would be that short-term financial, because Harvard Business School has cleaned me out. I don't think I'm the only person in that regard. I think most MBA candidates at this point probably have a negative net worth or something like that.

Royce Yudkoff:

I think that Ari is on to something here. If he raises money from investors to fund a search and his family’s expenses while searching, investors might have a strong view about the nature of his search, particularly a tight geographic restriction like, in Ari’s case, Miami or El Paso. Let’s hear some more about how Ari is considering where and how to search. 

Ari Santos:

I would love to self-fund my search and raise money when I have a deal because I feel like I have more flexibility in where the business is located and what the business is. But yeah, the problem is I cannot self-fund my own search. And I feel like when I do talk to a lot of people that said they went self-funded, it was really spouse-funded or parent-funded. And I think for me, I don't have that luxury. If I did self-funded, it would have to be a true self-funded.

Rick Ruback:

So then you'd fund the search.

Ari Santos:

Correct. I think I'd have to go that route unless I just find something within the next couple months, but then that feels like... What do they call it, where you're acquiring your job?

Rick Ruback:

Buying a job.

Ari Santos:

Buying a job. And not buying a business because of the rush timeline. This is something that I feel like I have to be thoughtful about.

Royce Yudkoff:

So this is where these two issues collide, family life and the type of search you're doing, which is, it sounds like, if you search, you really need to get a group of investors to fund you, but you'd really like to marry that with buying a business in Florida or Texas and you're not so sure that investors would agree to sign up to back you in a search if the plan was you're just confining yourself to those two states.

Ari Santos:

Yeah, that's the nail on the head.

Rick Ruback:

I think it's deeper. I think the search funders, the people who fund these days are largely wanting bigger acquisitions. And if you want to buy a blue-collar company, most blue-collar companies, I would guess, are sub $2 million in EBITDA?

Royce Yudkoff:

Yes.

Rick Ruback:

So, you're not going to be buying a business that's $15 million of total enterprise value or $20 million of total enterprise value. You're going to be buying one that's $5 or $6 million of total enterprise value. And so the funders are generally more interested in bigger businesses, not all, but some funders are certainly interested in bigger businesses. So, that's a concern to pay attention to.

Ari Santos:

That’s also an important consideration.

Royce Yudkoff:

So, what's happening then in your mind is you say, "If I fund, I might end up being pushed to a place or a business that I don't really want. And if I don't fund my search, I don't have any money."

Ari Santos:

I've considered, do I work part-time? Do I get a remote job? Do I consult online to fund my search? But yeah, because a lot of people say, "We're just living off of savings for the next year" or "My wife has an okay job." And that's not my case. It's between a rock and a hard place. But then it comes to this decision of self-funded, where I would have the agency but I don't have the money, or funded where, okay, now I have the money to take care of my family, and that's important, but I might be pushed in a direction that I don't want to go. Then isn't that a job, as you think about it? So yeah, these are what's rattling around my head.

Royce Yudkoff:

Such an intriguing conflict. I get it. I mean, I get it. And you might be able to find funders who are both comfortable with a blue-collar business and a geographical constraint.

Ari Santos:

And I've thought about, okay, I can increase a geographical scope to the Southwest United States and that encompasses Texas, New Mexico, Arizona, Oklahoma. OK, maybe an investor would be more comfortable with that? Would an investor be more comfortable with a smaller acquisition, essentially a holding company? Or I would need to aggregate a lot of these smaller businesses because I don't think you're going to find the size of the average HVAC, commercial landscaping, maintenance, things like that. I don't think it's the size that an average search fund investor would like. They exist. I'm sure they exist.

Royce Yudkoff:

Well, you know, it used to be that the investors who back searches would invest and were eager to invest in businesses with $1 and $2 million of EBITDA. And probably five to seven years ago, Rick and I started to see that group of investors change and, in large part, get oriented to bigger deals, as Rick said. But I wonder if in that fairly large population of investors, there's still people who would love to buy a $2 million lawn care business or HVAC business that's priced right, at four times EBITDA. I imagine there's a population there that could get really excited about that.

Rick Ruback:

I think there is, but I think it's not the people who have raised big funds.

Royce Yudkoff:

Right, you’d have to search through the population.

Rick Ruback:

You’d have to search to find the search.

Royce Yudkoff:

You’d have to search to do the search.

Royce Yudkoff:

I was just going to say what you're putting front and center is this money question of, "Could you raise the money for a search that's defined around buying a smaller, blue-collar business in a couple of significant regions of the country? Would you get the investor support?" I think that's a real question, because some people will think about search and not be sure and they'll go get a traditional job for a few years thinking they'll go back to it later, but I don't think this issue will go away. In other words, if you took a traditional job, you'd face the same issue in three years. It's not going to go away. So, it either gets solved or it doesn't get solved. But deferring it doesn't help.

Rick Ruback:

When it comes to funding the search, Allan is in a different situation. If he searches, it will be spouse-funded. In his words …

Allan Newman:

Spouse-funded, yeah. So, I'm very lucky there. You know, we're very much going through our budget. How have we been spending money? What's the next few years going to look like? But yes, it's a concern. We talk about it almost every day.

Royce Yudkoff:

So Allan, one of the implications of that is, as you know, there's two ways of funding yourself when you search. Some people self-fund or spouse fund, as you're doing. They have the resources to carry themselves until they get to the point of buying the company, at which time they look for some investors. And the other is going to some of the regular investors in search and raising a search fund and that fund will pay them while they search and fund the acquisition. You've decided to self-fund partly because you can, but are there other reasons you've made that choice?

Allan Newman:

Yes, and I think both are very good options for specific individuals. So other reasons are I'm going to be very geographically constrained, which I understand could limit the traditional search fund investors, as well as I'm still chewing on this growth thesis versus a sustainable business and how I'm going to operate it. So, if I'm optimizing for choosing which problems I want to solve when, I'm going to go for growth when I see it, not because I'm trying to hit equity targets or targets to try and earn more equity in the business. I want to go for what I think makes most sense at the right time versus I think there's a little more pressure for significant growth from traditional search funds.

Royce Yudkoff:

I want to test that I've heard you right. It's kind of one of the things you get when you self-fund is usually end up controlling the company you buy. And even though you have outside investors, you ultimately answer to yourself. And that might be expressed in setting the growth rate of the company, not based on investor expectations, but what's right for the business. It might be other things, but you're looking for that extra control you get.

Allan Newman:

Right. And there will still be investors in the self-funded and they're going to want to see the growth. But I think if I can curate that investor list… I have a lot of ideas I'm thinking about that… I'd also like to go a little smaller in the investment because I see this as a twenty, thirty-year journey. I see a lot of people who seem to buy one, operate for seven years, and then they never want to do it again. And that's a little concerning on why don't they want to do it again? So, I'd like to go maybe a little slower, a little smaller, and then go for a much longer time period of trying to run small businesses. So, it's my thesis. We'll see.

Rick Ruback:

I think it's a great approach. I think it's a fabulous approach. The smaller the business, the lower the multiple, the better the pricing of buying the business, the more opportunity to get to know the business. The other thing is you need less capital so you can really, as you say, curate your investors. And the interesting thing about the investment base for a business like that is investors will self-select. Investors will look at the business, will look at how you describe the business, will look at you and say, "Do I like this or not?" And the ones that say “yes” will want to be in your capital structure. Whereas if you fund the search, they have a style of what business you might buy and there's that nudging towards that style. And then when you buy it, they continually want to nudge you to that style because that's what they signed up for. In a self-funded search, you're going to get investors that really like the style of that business because they see it at the time they buy it. That uncertainty is gone that exists with funded searches.

Allan Newman:

And I think the step further then is that's my leadership style, which will theoretically lead to more success versus me trying to work on someone else's style and maybe not succeed in that regard as much.

Royce Yudkoff:

I agree with what both of you have been saying. I’d just add, I think there's a real consistency in a focused geographic search and opening yourself up to smaller size businesses because, of course, when you say I'm going to search, for example, only in New England, you're naturally reducing the number of businesses that could be your targets. But then by opening yourself up to go a little smaller, the pyramid of North American businesses gets wider and wider as you get smaller. And so, in a way, you're restoring a number of targets that you eliminated by going geographically tight. So, it's a very consistent strategy here, where you reduce some of the targets geographically but you expand them through considering smaller size businesses.

Rick Ruback:

It's a good way of thinking about it. So fit, I think we've already talked about. You think you're going to just fit better as a CEO than as a part of a bigger organization?

Allan Newman:

I think so. It really reminds me of back at West Point, people talking about the platoon leader job and company commander job. And I haven't got much of that. I've been looking at all the roles coming out of what you could do with an MBA and I think this is the best fit for my talents, at this point.

Royce Yudkoff:

Allan can pursue a Boston area focus by spouse-funding his search and potentially getting much better economics as a result, whereas Ari needs investor funding to support his search and his family. Do you think Ari can find investors?

Rick Ruback:

Royce, absolutely. But my guess is he’ll have a smaller group with different investors than many of the larger funds. But there are surely investors interested in enduringly profitable, blue-collar businesses that can be acquired at relatively low multiples. He’ll give up economics relative to an unfunded search but so what? He’ll likely do at least as well financially as in a traditional career and this entrepreneurship acquisition path just seems to fit him better.

Royce Yudkoff:

I agree, Rick. I think you'll find value investors out there who get excited about investing in an established business that's been around for 30 or 40 years and is profitable and now it's being taken over by an energetic person who's been well-trained in management and has skills managing crews of people. I think that seems like a no-brainer as an opportunity. I think some people might have pause about narrowing the geographic area, but you're not narrowing it to a small place. When you look at smaller, small companies, like we're talking about, there are a lot at the base of the economic pyramid. So, I'm with you, Rick. I think Ari will have to search a little harder to find those investors within the realm of search investors, but they're there.

Rick Ruback:

I’d like to cover one last topic in our conversations with Ari and Allan. Risk. Many people think searching is risky, and Royce and I always find that befuddling. After all, you can always just get a job if the search fails. But here we are, talking to these two veterans whose prior careers in the US Army exposed them to serious physical risk. How do they feel about risk? We’ll start by asking Ari for his thoughts on this topic. 

Royce Yudkoff:

This leads me to a question that's on my mind, and I think on Rick's, which is about risk. Most commonly, when Rick and I talk to people who are thinking about searching versus thinking about a traditional job in a large company, they have the view, "Gee, it's riskier buying your own small business. It's safer being in a large company." Something I don't think Rick and I actually agree with, but that's the common choice. This doesn't sound like that because the choice to you is buying your own small firm, a landscaping business, whatever, or joining an early-stage tech company, which seems fraught with risk to me. How are you thinking about risk?

Ari Santos:

I am comfortable with risk. As long as I'm able to do the internal calculus of, "Will this company succeed? Will I be okay?" There's a certain level of risk I'm probably not comfortable with but I'm probably less risk-averse than the average person. So that's not a huge factor for me.

Rick Ruback:

How does your wife think about the risk side? Does she think the search thing is just crazy or does she think it's really intriguing?

Ari Santos:

She thinks it's intriguing and I am really blessed that she does support me and I think she'd support me in basically anything I did. She's happy even now, even though we don't have a lot. Hey, we are living in Boston. We have a roof over our heads. So yeah, I'm lucky in that regard. When she hears of our friends taking $175,000 base salary jobs, it definitely raises an eyebrow for her like, "Hey, why didn't you apply to those jobs?" But I think she gets the bigger picture of why I want to do something like this.

Rick Ruback:

Can I ask kind of an off-the-path question? You'd be surprised if I didn't, right? So, in the Army, they have real bullets, right?

Ari Santos:

Yeah.

Rick Ruback:

Yeah. I mean it's a dangerous job. I find it really intriguing that some veterans think about this as risky, but they didn't think about the Army as risky.

Ari Santos:

I have never thought about it that way but yeah, 100%. It also depends on what you did in the Army or in the military, in general. There's a spectrum of risk within the military as well. So, I would say it depends on what that person did prior, but to those people who are taking huge risks with their lives in the military to not be willing to take financial risks, I've never thought about in those terms, but it makes sense.

Rick Ruback:

It's goofy that they're willing to take personal risk, physical risk, but then financial risks, they get really scared about. I think that's odd. You don't think that's odd?

Ari Santos:

It's 100% odd.

Royce Yudkoff:

Allan has similar thoughts about risk. 

Rick Ruback:

Do you worry about risk of failure as a searcher? Do you worry about risk in the business? How do you think about risk? I mean, I think it's an odd question because you guys have faced real risk.

Allan Newman:

Well, that's what I think about a lot because we have different definitions of risk. Every helicopter flight is inherently dangerous, but now I'm thinking of taking on a million dollar loan plus that will be paid over ten years. How to transition risk thinking in that regard is quite a difference. So yeah, I think about risk. I think there's a failure to thrive thesis as well, that you're not going to go bankrupt, but you're going to be working in this small, not growing, not really succeeding organization, basically paying off someone else for the next 10 years of your life, would be the downside risk.

Royce Yudkoff:

Meaning paying off the lender, for example?

Allan Newman:

Right. The lender who has paid that cash to the seller and essentially I'm going to be working for that seller or lender for the next ten years. Oh, the other piece I want to mention is there's a lot of great mentors, a lot of great community in HBS that gives me the confidence that I'm going to pick up the phone before I get in the situation and then, if I do get in the situation, to figure out a way out and that brainstorm, talking to a lot of people, that I have the confidence that we'll be able to figure it out.

Rick Ruback:

Yeah. I think what you describe is sort of an unhappy circumstance. You buy a business, you think it's going to be great, you lose a good customer or something bad happens, there's some innovation and you just slog along repaying the debt. And that doesn't seem like you. It seems like if you find yourself in that situation, you'd find a way to fix it. Having participated in this community for nearly a decade and a half, one of the things I note is that every CEO faces challenges and every company faces unanticipated hurdles. What's special is that many people, people like you, look at those hurdles as things that need to be fixed. “What do I do to solve this problem? And I just solve this problem.” It's not, "Oh, this is really terrible. I'm stuck now." You're just not going to ever be stuck. You're going to fix it, whatever it takes.

Allan Newman:

Right.

Royce Yudkoff:

Allan, how about the solitude of the CEO role? How do you -

Rick Ruback:

I think he's going to like the solitude of the CEO…

Royce Yudkoff:

Well, I don't know. That's why I'm asking, you know, because in some ways, in a large organization you have a large peer group, you know, who can share experiences, commiserate, advise. Surely you have an informal peer group when you're your own CEO but it is, as they say, it's lonely at the top. How do you reflect on that?

Allan Newman:

The answer for me is I have a very good and close relationship with my wife and that's what I'll rely on, channeling more into that for the harder times.

Rick Ruback:

It sounds great.

Rick Ruback:

Towards the end of each episode we like to ask our guests if they have any questions for us. We briefly touched on this earlier, but Ari asked us an interesting question about his search thesis and that’s what we’d like to share. Here’s Ari.

Ari Santos:

I have one question, because this is something I hear a lot. What is your opinion on having a super well-defined thesis?

Rick Ruback:

I think your thesis is “I want to be in Miami or El Paso and blue-collar”. I don't think you need any more definition than that.

Ari Santos:

That's good to know.

Royce Yudkoff:

I agree.

Rick Ruback:

With those constraints, you got to be open-minded.

Royce Yudkoff:

Because often with small companies, you see a business you didn't even know existed or it wasn't on the top of your agenda, pool maintenance company or a specialist repairer of pool heaters. This journey leads you to places where, “Look at what that amazing entrepreneur created over 30 years. I didn't know that business existed.” You want to be open to that.

Ari Santos:

Yeah.

Rick Ruback:

There are so many businesses like that. There's septic businesses, there's water businesses, there's trash pick-up businesses...

Royce Yudkoff:

Roof repair businesses. It just goes on and on, and you need to be open to all of those because they're exchangeable with each other, really, for your purposes.

Rick Ruback:

And the trick to searching in that space is you want to keep a keen eye towards recurring revenue and you want to find one of those businesses that you're both unimportant to their cost structure and that customers either repeat or recur.

Royce Yudkoff:

And speaking of recurring revenue, and other important factors to consider when searching for a small business to acquire, Allan had a great question for us as well. Let’s listen.

Allan Newman:

You need to practice to do, right? There's one graduate, he owns an internal fan company in Texas, I think, and he has one employee. And his thesis is you got to get your hands dirty. You got to know the job before you can leave the job. So, do you really need two years in recurring revenue? Do you really need the recurring revenue or is it worth it taking a higher risk to start a CEO position earlier? This is quite a long.

Rick Ruback:

No, I get the question. And the question, more generally, is do I take something which is well away from perfect…

Allan Newman:

Yes. I guess how far away from perfect to start being that?

Rick Ruback:

…to just get going?

Allan Newman:

Get in the seat.

Rick Ruback:

I think everybody makes the trade-offs differently.

Royce Yudkoff:

Yeah. I think that one of the keys to being a successful searcher is recognizing that no business you can buy is going to be perfect, especially if the price you pay is included in the bundle of things you're considering and how much can you compromise and still buy a really good business. And I think that's something you pick up through experience searching, where you look at scores and scores of firms so that you can recognize a company and say, "I know it's not perfect but it's in the upper quartile of the 50 businesses I've seen” is how you get comfortable with that decision.

I think in the example you just gave us, which was “Should I just go really small like this person did?”, I think small can be a nice trade-off because you can fix small, right? You can fix small by doing good work and getting new clients and you can build the business bigger. I think what you described there, to me, sounds too small, right? Because you have a lot of experience and skills and you want to leverage that with the appropriate size of business so you're being rewarded for the work you're doing.

Rick Ruback:

Yeah. But it's interesting you should say that because I had occasion over the weekend for somebody to describe a business that they said it's a perfect business, didn't have long-term contracts but it had recurring revenues…we didn't have financials, but I would guess it was like $150,000 of EBITDA and like three employees. I was like, "No, no."

Royce Yudkoff:

That's a job, that's not a business.

Rick Ruback:

That's a job. It's not a business. Okay. So let's try this. Here's another way of asking the question of how far from perfect can you be? Imagine the perfect business being a million and a half dollars of EBITDA, 75% recurring revenue, no customer concentration, in a business I can easily understand that doesn't compete with Home Depot, Walmart, you know, somewhat defensible, good service. I know the customers, but no customer concentration. Say 25, 30 customers are reasonably distributed. Is that fair?

Royce Yudkoff:

Sign me up so far.

Rick Ruback:

I would say 15 to 20% EBITDA margins and maybe 50% gross profit margins. Okay? All right. I'll ask the questions. You guys can answer. And we're going to buy that at 5X, did I say?

Royce Yudkoff:

You didn't say, but..

Rick Ruback:

Let's say we're going to buy that at 5X.

Royce Yudkoff:

…it's a reasonable small company price for a business like that, five times EBITDA, five times pre-tax profit.

Rick Ruback:

Yeah. And I'll finance it with the SBA loan and all that other stuff. So, suppose we move one and a half million dollars to $750,000, but leave everything else unchanged. Would you buy it?

Allan Newman:

Yeah, I'm very eager to.

Rick Ruback:

You're very eager?

Allan Newman:

I have no problem with that.

Rick Ruback:

No problem. What would you pay?

Allan Newman:

You could bring the multiple down because of the size. So, four.

Rick Ruback:

You'd pay four. Royce?

Royce Yudkoff:

Yeah, I would buy it small here. Sounds like it's very fixable through hard work and growth. And I'd probably cap out at a four multiple on that. Somewhere between three and four for a $7 million business.

Rick Ruback:

Okay. Next question: 50% customer concentration. We're back to the million and a half. Everything as otherwise I said is true except this 50% customer concentration on revenue. So, it's probably more than 50% customer concentration on profits. Where are you at, Allan?

Allan Newman:

I wouldn't.

Rick Ruback:

And I saw you pressing the eject button.

Royce Yudkoff:

Well, this is like one of those afternoon game shows. Zzzhhh! You're out. That's also like having a job where you work for that customer except that customer has no hesitation about firing you if they can get something better.

Rick Ruback:

Okay. Now, we're back to the same company, a million and a half dollars. Only instead of 75% recurring revenue, you have 50% repeating revenue. So, no long-term contracts, no visible commitments, but the same customers come back. Customers tend to come back each year and it's about 50% of your revenue is associated with customers you've done business with. So, it could be a project business where you're doing different projects for the same people. So, what do you think? Are you in on that?

Allan Newman:

Yeah. And so for better or worse, I don't have a problem with that, which makes me question if I should be doing search at this time because do I have a good understanding of the risk? Because I'm in all day on that?

Rick Ruback:

You're in all day on that. Royce?

Royce Yudkoff:

I like it. I think it calls for some more questions to be asked. Like, I feel better about that kind of repeating revenue business if what brings the customer to your door is required, like you're fixing their heating equipment when it breaks. And so you're counting on a steady flow in your catchment area of that equipment breaking and then they come to your door or competitor. I feel less good if it's a discretionary project that customers could cancel if there's an element of cyclicality in it, for example, which you sometimes see in reoccurrence. So, I like it too. I'm with you, Allan, but I think that there's some nuances to be explored.

Rick Ruback:

It was a trick question. Do you know why it was a trick question?

Royce Yudkoff:

Tell me why.

Rick Ruback:

It's because I had the margins up. I didn't change the margin. So, you still had your 20% EBITDA margin on the repeating business.

Royce Yudkoff:

Which suggests that these are not discretionary purchases that when someone isn't getting any heat, you're their first call and you're going to get the business at any pricing. Nice trick.

What I actually liked about this, Allan, is that this is what you gain when you start to search. In other words, you see a whole bunch of case examples like this and almost like the optometrist, you're saying better or worse, better or worse. And by the time you get to the 50th business or the 70th business, you can really see where this lodges in the companies that are for sale, what they really look like. And you become better at these choices.

Rick Ruback:

I had one more A-B test since we're back to the optometrist analogy. How about I keep the same business, a million and a half dollars of EBITDA. I've taken away the customer concentration. But here's the thing, the margins, the EBITDA margins, are 5% instead of 20%. So, I have to do a lot more revenue to get to the same EBITDA.

Allan Newman:

I'm not a fan because, yes, much more increased revenue for bottom line, but also it tells me I'm not that valuable and people have a lot of power over me, whether it's suppliers or customers or both, and I don't want to dig out of that.

Rick Ruback:

So earlier you said that you weren't sure you knew enough to search.

Allan Newman:

Yep.

Rick Ruback:

You just passed the test because Royce likes to say if there's one measure...

Royce Yudkoff:

It's margin, right?

Allan Newman:

Yeah.

Royce Yudkoff:

If you have a 5% margin business, the first question you should ask yourself is, “Why does this owner not raise price by 5%?” Because that 5% price increase would double his 5% profit margin. And there can only be one answer to that, in most cases, right? He is afraid that his customers will dump him if he does that. And that is a bad business, if customers can substitute you out over such a small price increase.

Allan Newman:

Right.

Royce Yudkoff:

Yeah, I agree with Rick. You did a nice job on it.

Rick Ruback:

You did a really nice job. I wouldn’t worry about a thing.

Rick Ruback:

Royce, these conversations with Ari and Allan were so interesting. 

Royce Yudkoff:

I loved the clear thinking about the choices and how the entrepreneurship through acquisition path dovetailed so nicely with who they are as people, their career aspirations, and their hopes for their families’ futures. 

Rick Ruback:

I love it and, like you, I think there’s a lot to learn from their thoughtful considerations and clear thinking. The question always, I think, is how searching will work for you and your family and how to tailor the journey to meet your personal needs. 

Royce Yudkoff:

One last thing, Rick. Do you think that Ari and Allan will search?

Rick Ruback:

I think so but let’s do this. Let’s come back to each of them at the end of this first season of the podcast and check in with them, to see what they’re doing and how they’re thinking about things.

Royce Yudkoff:

I look forward to that.

Rick Ruback:

Thanks to our guests, Ari Santos and Allan Newman, for joining us on Think Big, Buy Small. We really enjoyed our conversations with them and learning more about how they’re thinking about the decision of whether to become searchers or not. 

Royce Yudkoff:

And thanks to all of you, our listeners, for tuning in.

In our next episode we’ll be speaking with a successful searcher, Jackie Kopcho, who is now CEO of Tortorella Swimming Pools, in New York. She has walked the entrepreneurship through acquisition path and has great insights to share with us…