Welcome back to this week’s edition of Search Fund Insights.

Sorry for the long break since the last edition- as you can imagine, the last couple of weeks have been extremely intense but I will try to keep you all updated with our progress. To make up for it, this week’s edition is a little longer but I promise full of valuable insights for all searchers, future searchers, and investors. Still, I know many of you have very limited time, so here are the key insights:

TL;DR

• Buy & Build Strategy: This approach involves acquiring a platform company and making several smaller add-on acquisitions to create value through economies of scale, operational efficiencies, and market expansion.

• Limited Management Experience: Young searchers can benefit from M&A expertise, starting in roles like Co-CEO or Head of M&A to learn the business before managing day-to-day operations.

• German Market Potential: The German SME market is ripe for buy & build strategies due to fragmentation and megatrends such as digitization and demographic changes, making it ideal for market consolidation.

• Value Creation: While margin expansion through operational improvements is crucial, realizing multiple expansion by enhancing company value for future buyers is equally important.

• Strategic Benefits: Combining operational improvements with strategic acquisitions can drive significant growth and higher returns, making buy & build a compelling strategy for search funds.

As many of you know, during my studies I freelanced for a couple of investors (PE MDs) and set up a buy-and-build roll-up story of vet clinics. This was my first encounter with self-funded search funds although, at that time, I had never heard the term “search fund” before. I first heard the term “search fund” last year when I decided to pursue this roll-up idea on my own after identifying a great market opportunity, but this time backed by investors for the acquisition equity. Little did I know that there was a big community behind it. Having a private equity background, I was surprised to learn that most searchers primarily focus on value creation through operational improvements rather than planning with a lot of inorganic growth.

Today I want to explore why I believe searchers should be open-minded to adopt some private equity strategies, such as buy-and-build, especially German-based searchers (as well as in similar markets Benelux, etc.).

How does Buy & Build work?

A buy & build strategy involves acquiring a platform company and then making several smaller add-on acquisitions to enhance value through scale (resulting in a strong multiple expansion - remember the Connexta case I mentioned in my first newsletter that sold for >13x, where the PE bought platform + add-ons for 5-7x), operational efficiencies (centralization of administrative tasks, procurement, etc. and thus lowering costs through economies of scale), and market expansion (tapping into a new geography or service-line with acquiring an already.

This approach leverages the entrepreneur's expertise in identifying synergistic targets and integrating them to create a stronger, more competitive entity (and thereby achieving higher exit prices). The idea is to ensure that 1+1=3 by capturing the benefits of scale and scope. By consolidating fragmented markets, search fund entrepreneurs can drive significant growth faster and with less operational risk. Growing from €1m EBITDA to €3-4m is way easier by additional acquisitions than actual operational improvements (however it is NOT either or but a cocktail of both approaches). Operational improvements mainly revolve around an effective integration of the add-ons.

Limited Management Experience and playing your strengths

I think most searchers and investors would agree that limited management experience is one of the biggest challenges for young searchers. While we all think that post-business school we can effortlessly manage a company, I think there are many (many) risks that one definitely should not underestimate. While a young MBA perhaps often knows the technicalities and theory better than anyone, we will all find the real-life experience to be very different after all! At the Insead Search Fund Conference the sentence: “Buy a business so simple that not even an MBA can destroy it” was stuck with me! While of course, this is exaggerated, management is a game of experience and market knowledge and not about who can build the best theoretical case in Excel.

Additionally, apart from actually managing the company, convincing a very senior, conservative German “Mittelstand” Seller who built this company for 30+ years that this young MBA in their 20s will buy and manage this business is arguably and for very valid reasons the biggest challenge in the search phase!

As mentioned in my last newsletter a good side benefit of pursuing a self-funded buy & build approach is that - highly depending on the company - do not have to be CEO. Having the premise that there is already a good CEO in place or a COO etc. that can be promoted to CEO, I would be very happy to enter as Co-CEO or even something like “Head of M&A”. A big learning from search fund entrepreneurs I spoke with was to not rely on the negotiated transition time of the seller / former CEO. Joining as the operational #2 gives me the time to learn the business perfectly in detail and not have to manage the day-to-day on day 1 and focus on the craft that I know - deal-making and focus on learning another valuable toolkit in our business line called “post-merger integration”.

Additionally, I experienced that this can be very comforting to sellers and thus be a great selling point!

The German market

The German SME market (”Mittelstand”) presents unique potential for pursuing a buy & build strategy across various sectors. Germany (and other similar Western European markets like the Benelux) are challenged with many very obvious megatrends like digitization, demographic changes, urbanization, new work methods, etc.

From a buy & build perspective, some trends provide great starting points for finding strongly growing but fragmented markets that make good cases for consolidation through M&A and are left alone because of urbanization (i.e. pest control, HVAC businesses, or my beloved veterinarian clinics). Other trends bring out the potential for integration methods (for instance the remote work potential for efficiently staffing the workforce of your IT-Services roll-up between acquired companies, i.e. one could staff employees from your add-on in Munich on the new project of platform company in Berlin while the customer is based in Frankfurt and thus increase your workforce utilization/revenue per employee). Cases like that could bring enormous value that you could leverage in a buy-and-build play.

Value Creation through Margin Expansion vs. Multiple Expansion

To be clear, as I have seen many of those cases, I do not claim that doubling the EBITDA margin through a few “quick fixes” can’t be done. For instance, we are currently looking at an IT-Service company that excels in reselling licenses (which have low margins for obvious reasons), but despite customers often asking and having a great need for it, cannot manage to build a strong managed-services team (which carries attractive margins of 20+%). Acquiring another service company to realize all the potential revenue from existing long-standing customers who have the need could almost certainly strongly increase the company’s average EBITDA margin.

Do not get me wrong, I do think margin expansion is extremely important to look out for and data shows that this is what makes the top returns.

However, aside from cases like the above, my observations are that in most cases, value creation through margin improvements is often over-estimated, while multiple expansion is frequently overlooked in projections.

If you have no experience in the world of M&A, realizing the potential of multiple expansions can be easily overlooked as it needs to be focused on from day 1. In a nutshell, the searcher would need to rebuild the company in a manner that a potential buyer will pay a higher multiple for it than you bought it for. Although there are unlimited ways to measure a company's value, keep in mind that a company is always worth as much as a potential buyer would pay for it.

A buyer pays a high multiple for a company that shows the following things (always relative to your market):

1. High growth potential (which is btw the rationale behind high software multiples for startups and can be done in a buy & build strategy by entering new markets or acquiring new service lines). PEs for instance always keep in mind the value creation story for a potential buyer. If all the potential is already realized and there is nothing to do anymore, why buy that company? Luckily in a usual search fund holding period, you can’t possibly realize all of the synergies as most take years to show their fruits)

2. Minimizing risks (there are numerous ways of doing so and I would always focus on the low-hanging fruits)

Classic approaches are for instance lowering the customer and/or supplier concentrations. Another one would be lowering the dependency on the CEO (by building strong management as well as second and third-line management).

I believe one should always play their strengths. Although managing the day-to-day is something I would enjoy, I realize that I have never managed firms with more than 10 employees (in my times as founder) but however, went through a short but intense school of private equity that carried many (many) learnings and made me rethink businesses completely. Thus I completely understand that buy & build might not be the right approach for someone else as it carries other risks like dealing with many sensitive topics during the post-merger integrations (for instance maintaining a good company culture), dealing with raising financing costs that can be very challenging or challenging with the company group getting to fragmented and thus fragile.

However, it is certainly a strategy that could carry a lot of high returns, great deal-making as well as management learnings, and especially a very interesting and unique story company story.

I hope you enjoyed this week’s longer edition and I would love to hear your feedback and if you agree or disagree with my views. Also, I plan on doing a market deep dive as one of the next editions, so feel free to propose markets that you would be interested in (by just replying to this e-mail).

• Additionally, I can highly recommend to all searchers reading reports like this one - at least I had some "Aha"-moments while reading it. Apart from Bain, also other larger consulting firms, banks, and PE investors frequently publish reports like this.

See you next week for the next edition!

Best, Yassin

Welcome back to this week’s edition of Search Fund Insights.

Today, I want to share my personal take on the German market, highlighting why it is such a unique landscape and its potential and challenges for search funds. Specifically, we will cover:

• The distinctive characteristics of the German market and the potential it offers

• The German Private Equity landscape and how we aim to complement rather than compete with it.

• The conservative mentality of German sellers and strategies to navigate it.

For those who don’t have time to read the entire post, as always, there will be a TL;DR at the end!

Whenever I speak to international investors, I often hear about the difficulties of the German market. Issues range from the conservative nature of sellers (especially when dealing with younger entrepreneurs) to the competitive environment shaped by private equity, and even the old-school methods of deal sourcing like sending physical letters.

Honestly, despite these challenges, I remain quite bullish on the German market. I acknowledge the issues, but today I want to discuss how we turn these perceived disadvantages into opportunities.

Market Size and Pressure for Succession

Let’s start with the basics. The German searchers and investors should all know these numbers, but for the rest, here is a quick overview of the current need for succession in Germany.

KfW recently published a study with some really concerning headlines for Germany. By the end of 2027, an average of 125,000 SMEs will need to plan their succession and currently do not have a successor in place.

Of course, most of these companies will not fit the search fund or PE criteria, but if you dare to think a little outside the box, I’m sure you will find great opportunities in Germany.

Why is the succession pressure so high?

Germany’s economy relies heavily on the “Mittelstand” (SME companies). It was built by a great generation of founders who are now moving into the second or third generation of successors. However, something is changing. Even if the owners have children, often kids do not want to take over their parents’ “boring business” and stay in their hometown. They would rather (to put it bluntly) move to Berlin and pursue other interests. Even if it is a super profitable, growing company with lots of potential.

Entrepreneurship in general has issues (also founders) but succession is probably one of the biggest problems the German economy currently needs to deal with. Below is the chart showing the declining number of founders (in blue) and the even more disappointing number of succession entrepreneurs (in green).

Private Equity Landscape and How I Avoid Competition

Private Equity has long recognized these opportunities, resulting in a unique PE landscape in Germany. Compared to the US or other European countries, Germany has a significant number of small and mid-cap PE firms.

Players like Auctus and Aurelius (and many others) are successfully rolling up markets and targeting sizes that are typical search fund targets in other countries. This is a key reason why there aren't many search funds in Germany—PE firms have already filled much of that space. At the INSEAD Search Fund conference, it was suggested to position yourself as the opposite of a PE firm and appeal to owners who avoid (exaggerated) "evil" PE companies. However, German PEs are improving their reputations, offering management support, industry expertise, more capital, and strong track records.

As a search fund entrepreneur, I saw two options: source proprietary deals to avoid PE competition or target smaller companies (€0.5-2m EBITDA) to stay out of their radar.

Many search fund investors don't support these smaller sizes, which is another reason I chose a self-funded structure. Their rationale behind this is that if you buy a company making €800k EBITDA, you’d need to grow it to €4-5m EBITDA to be large enough for a successful PE exit. That’s more than 6x growth, which is obviously very challenging. This is, however, not the case in Germany!

The advantage here in Germany is that, given the German PE approach of targeting smaller companies, you don’t need to grow to €5m EBITDA for a PE exit. You can attract PE buyers with €1.5-2m EBITDA and secure a good price.

As a disclaimer, I’m not saying that the traditional search fund model won’t work in Germany (as there are plenty of opportunities and already some very successful cases), but I see a lot of hidden potential in rolling up smaller companies to grow. Our sweet spot, for instance, is around €1m EBITDA.

Mentality Issues

Another significant challenge in Germany is the conservative mentality of sellers. Selling a third-generation business that generates millions in profit to a young entrepreneur in their mid-twenties or early thirties with limited to no operational experience, especially in the target industry, doesn't seem appealing to risk-averse company owners.

Remember, these sellers often live in the same small town and see their employees every day, even after selling. If something goes wrong, it has a huge impact on their reputation and friendships.

We try to tackle this issue with flexibility. As mentioned earlier, we aim to execute a buy-and-build strategy, focusing on post-acquisition M&A financed mostly from cash flow and additional debt. If the seller doesn’t want me to be the CEO or already has a potential COO in place to handle daily operations, I can leverage my M&A and PE experience to focus on M&A and strategic decisions. If there's someone who knows the business better than I do, why not utilize their expertise? This is not the classic search fund approach, and many investors pass on this model, which is another reason I chose the self-funded route.

Of course, if the seller has no problem with it, I am more than happy to run the day-to-day activities, but we are very flexible on the structure. It’s still early to see if our approach will work out, but I will keep you all posted.

TL;DR

• Germany is the largest European market for SMEs, filled with amazing, profitable companies facing a significant need for succession. This creates great potential for search funds.

• The German market has a unique PE landscape with many small-cap PE firms already targeting the typical search fund opportunities, which is why we're focusing on smaller companies to avoid direct competition.

• There's a very small and even declining number of succession entrepreneurs, with still limited but thankfully growing search fund activity.

• Lastly, German sellers often have a conservative mentality, preferring not to sell to young, inexperienced entrepreneurs. We address this by offering flexibility in our roles, focusing on M&A and strategic growth rather than day-to-day operations if the situation requires.

I will also start linking here some other good podcasts, blog posts etc. that I find and might be interesting for you:

For the German speakers there is this weeks OMR Episode with the co-founder of Goodgame (Kai Wawrzinek) who started right out of university by acquiring gaming websites in the early 2000s without investors and a €500k bank loan and ended up building one of the biggest game publishers in Europe.

Thank you for reading this week's edition of Search Fund Insights. I hope you found my perspective on the German market insightful. As always, your feedback is welcome. Feel free to reach out with your thoughts or questions.

Until next time,

Yassin