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Relay Investments has decades of experience in SF investing. How would you describe your investment philosophy, and how has it evolved over time?
Our investment philosophy has remained largely consistent, though our approach to investing has evolved significantly over the years, reflecting our growth and development. To begin with, our core philosophy, searcher first, has not changed: we seek partnerships with talented individuals who possess entrepreneurial traits, a willingness to learn and be mentored, and the ability to reinvent themselves.
Fundamentally, investing in a SF is about investing in people, not assets. We aim to create value for our searchers and CEOs, helping to ensure their success. Our team, assisted by technology, is exceptional in this regard, comprising former searchers and operators, and transaction-oriented individuals, and all focused on people. We cover nearly all the needs a searcher might have on an on-going, and as needed basis.
Our approach has evolved considerably, mostly as we started investing as a personal investment strategy, and then changed to investing as institutional investors, when Relay was founded in 2013. Pre-Relay, we relied heavily on the instincts of our searchers and our own. If an idea seemed promising, we would invest and use the investment amount as the leverage (more if we felt the opportunity was particularly exciting, and less otherwise).
Today, we employ a much more rigorous approach. We have a structured underwriting process where we review a deal multiple times to ensure nothing is overlooked. One team member assumes the role of Lead Investor and presents the deal to our Investment Committee, ensuring that our pattern recognition and extensive investing experience are utilized effectively. We have an extensive database/CRM of past deals and contacts to help us provide the best possible feedback to our searchers, including potential Board members, often either Operating Partners of ours, or investment team members at Relay, as appropriate.
We focus on robust risk management to ensure the searchers’ success and help them identify the right opportunity, which ultimately leads to lower loss ratios. We are known for asking the most thorough questions during due diligence, and often the tougher ones, which searchers consistently appreciate. With our 30-year track record and extensive network of operating partners, we have helped searchers avoid hidden issues. Our approach is all about ensuring that the best searchers enter the right deals and that we always feel comfortable with the downside scenario while preserving growth optionality.
With over 200 SFs backed and more than 130 companies acquired, what key characteristics do you look for in searchers? Are there specific skills or traits you believe are essential for success?
Primarily, we seek to partner with talented and ambitious individuals who also possess high moral values. Our comprehensive selection process, which includes three to four interviews with various team members, ensures that we make well-rounded decisions based on these values and certain key traits, such as:
- Purpose: We begin by understanding the prospective searchers’ motivations. Why do they wish to launch a search and become CEOs? As the search model has gained popularity, it is crucial that individuals are fully aware of what they are committing to. While average and median return numbers are attractive, the search process is not suitable for everyone. The best searchers are well versed and ready to tackle any and all challenges, even “running through a wall” to succeed…
- Skills: We assess their existing skills. Are they already proficient operators, or do they have a transaction-oriented profile? We need to understand their strengths and weaknesses.
- Follow through: The search is really a sales job, selling a company owner on the ability of the searcher to pick up where s/he or they are leaving off. In order to keep the momentum going, solid follow through is critical to increasing the success rate of finding a good acquisition target.
- Personality: As with the prior point, this too is critical: we evaluate whether the searchers will be credible and likable, and how engaging they are.
- Coachability: We seek individuals who are eager to learn and be mentored. Therefore, we assess their listening skills and openness to coaching.
- Entrepreneurial mindset: Executing a deal and stepping into the role of CEO for the first time is a challenging job that isn’t suited for everyone. It requires an entrepreneurial spirit to navigate and overcome the inevitable challenges (and trust me, they will arise). That passion and energy, so characteristic of successful entrepreneurs, is exactly what we seek in our searchers.
- Complementarity (for duos): For teams, we evaluate their complementarity and the nature of their relationship. We encourage partners to work on a partnership agreement to ensure they have been thoughtful and considerate of each other’s abilities, needs and wants.
Do you think some markets are becoming saturated? How can searchers effectively differentiate themselves in a competitive environment where more individuals are launching SFs? How might AI help new searchers in their quest for the perfect company?
Discussions about market saturation have been ongoing for as long as I can remember. When we had 15-20 searchers fund raising in the US simultaneously, there were concerns about oversaturation. The reality then and now has been that there are huge numbers of potential targets, and they change daily (there are new owners contemplating an exit all the time). Just look at how many PE funds are pursuing the large companies out there and seeing that, it is hard to justify the fears of saturation at the micro end of the market.
However, we are seeing higher levels of competition for the better deals in certain markets such as the US, Spain, and Mexico. When I was running Cameraworld in the mid to late 1990s, I was receiving many solicitations to buy my company, but those were typically by mail, or by phone and manageable. Today, business owners receive large numbers of emails from searchers, in addition to the calls and letters, indicating tighter markets. Despite this, acquisition rates have not significantly changed in the past five years, and there are still many businesses without transition plans compared to the number of searchers. The focus has increasingly shifted to the searchers themselves and how they will continue the owner’s legacy. Searchers are encouraged to narrow their search to companies in 2-3 industries at any given time, making them more knowledgeable about their targets (they can drop and add industries when initial ones turn out to be tough) and thus coming across as differentiated and more qualified buyers.
Additionally, the Baby Boomer generation, one of the most entrepreneurial in history, is now reaching retirement age, creating a global transition dynamic. Combined with the fact that younger generations often have different lifestyle preferences than their predecessors, SFs have emerged as a natural model for passing on companies and entrepreneurial legacies to a new generation of young, hard-working, and well-prepared entrepreneurs.
Regarding AI, it relies on others’ experiences and deprioritizes individuality and initiative, so not always helpful, however, searchers are starting to experiment with it to find their best approach, and it can help craft more tailored outreaches. It is also important to clarify that there is no such thing as a perfect company. This concept does not exist in public markets, and even less so in SMBs. Even if such a company existed, a searcher would likely not have the financial means to acquire it.
You outperform the industry average. What is your “secret sauce”? What resources or expertise does Relay provide to searchers, and how do you support them throughout their journey? How hands-on is your team?
We benefit from a virtuous cycle that has been growing over decades now: excellent results lead to partnerships with outstanding searchers who receive exceptional advice and guidance from our team, resulting in continued success. This cycle perpetuates itself.
We serve as a comprehensive investment partner, assisting our searchers from fundraising to acquisition, and from there through exit, every step of the way. Our commitment to being long-term partners is genuine. At the outset, our searchers receive a ‘searcher starter pack’ containing numerous useful templates (Gantt charts, LOIs, investor updates, etc.) to help them get up to speed quickly. During the search process, our team maintains close contact with the searchers, meeting regularly to discuss their progress, prepare for seller meetings, or discuss pre-LOI valuations, and in doing so, helping steer searchers away from companies with meaningful downside risks (high customer concentration, for ex). We make introductions to bankers, and quality of earnings specialists. Our extensive experience is a valuable resource for our searchers. Creating a sense of community is also important. Clem, one of our Principals, organizes monthly forums where we discuss various topics collectively (e.g., structuring deals).
Additionally, we leverage our wide networks to fill any gaps in our knowledge, contacts to river guides and potential Board members. We have numerous operating partners categorized by industry and functional skills. For instance, many SMBs struggle to establish efficient sales organizations. In such cases, we bring in an operating partner with a proven track record in this area, both within the search world and beyond.
Once a searcher acquires a company, what are the top three pieces of advice you would give them for their first year of managing the business? What common errors do you see as they transition into the CEO role?
- Don’t Rock the Boat: The first year should be dedicated to learning and understanding the company you have acquired and avoiding drastic changes. It is crucial to avoid making significant changes without fully comprehending their potential impacts. A good relationship with the seller can be critical, this is a sensitive time for them and understanding that can sidestep misunderstandings and resentment.
- Maintain Transparency:
- First with your employees (eg vision/high level strategy, how you value all)
- Second with the Board: It is understood that mistakes are inevitable as a first-time CEO. Being transparent with your board allows it to provide the necessary support and guidance to help you improve [very different than almost every other situation the searchers have likely been in]. Need to be very open with the bad as well as the good… and early on.
- Identify and Engage Key Stakeholders: Following a major transition, it is essential to spend the first year getting to know and reassuring your employees, customers, suppliers, and financial institutions and to be honest and cautious, not over promising to any of the stakeholders. The searcher needs to build trust and respect.
- Be humble: The typical employee will have a very different background and ambition to the searcher.
You’ve recently launched a specific fund for Europe. Could you tell us more about this fund, including its size, team, and geographical focus?
Yes, we announced the launch of our dedicated European fund at the IESE Search Fund Conference in October, where we celebrated our first close. Europe is an incredibly dynamic environment for SFs right now, reminiscent of the U.S. a decade ago. We are seeing a growing community of operators and investors who understand the model, a large base of SMEs that form the backbone of the European economy, succession challenges as many business owners approach retirement, and supportive bank debt options. Europe excites us greatly due to its rapid growth in search activity, acquisitions, and exits, while still offering substantial untapped opportunities.
This momentum, reflected in the rise in European searchers and the doubling of PPMs we have received in recent years, inspired us to launch Relay Investments Europe, a 100% Europe focused institutional investor, the only one based in Europe with a US heritage. Relay and its Principals have been investing in Europe for over 15 years and were the first institutional fund led by Europeans to invest in Europe. This is Relay’s fourth fund and the first dedicated exclusively to the European market. For this venture, we have partnered with three experienced European ex-searchers and investors, Ivan Peña, José María Vara, and Matthias Knaur, who bring valuable operating and investing expertise. Relay Europe combines Relay Investments’ 30-year track record (with 15 years in Europe already), with 68 successful exits (including a number of top-quartile exits in Europe), with local support to guide and empower European searchers on the ground.
Our European fund targets a size of €40-60 million, with a goal of investing across all European countries and with a sector-agnostic approach. We aim to acquire 35-50 operating companies, positioning ourselves as one of the lead investors to provide dedicated time, resources, and experience, helping our searchers succeed. Additionally, we will allocate part of the fund to follow-on and growth rounds for companies (both portfolio companies or through equity gaps) that have demonstrated exceptional performance and require additional investment to support and accelerate further growth. This could include organic expansion, add-on acquisitions, international market entry, or other strategic growth initiatives.
Relay Investments has worked with searchers across multiple regions. What do you see as the biggest barriers to entry for SFs in emerging markets, and how can these be overcome? Do you think the APAC region might be the next booming market?
Launching a search fund in a new country presents several challenges. Firstly, the country must be viable from a macroeconomic and demographic perspective, with sufficient size, growth, and a substantial number of companies with owners nearing retirement. Secondly, the capital markets must be liquid, providing access to acquisition debt at reasonable rates and ensuring equity liquidity (through public markets or private equity activity) for a successful exit. In addition, there needs to be a cultural fit, as succession can look very different in for ex developed countries where owners often have fewer dependents and there are often no expectations that a child will take over the company, unlike developing countries, where there can be different expectations. Tax treaties and foreign exchange fluctuations needs to be considered. Lastly, having a local presence and investor base is crucial, as the model may be unfamiliar in the country, making it challenging to attract investment. Investors need to be aligned on engaging and supporting first time CEOs. While these challenges are significant, they are not insurmountable. We have successfully launched SFs in several countries over the years. We do not have much experience with APAC other than Australia.
What are some of the biggest challenges you foresee for the SF model over the next 5-10 years, and how is Relay Investments preparing to navigate them?
We anticipate challenges on both the investor and searcher sides.
On the investor side, one of the defining characteristics of the SF model is its collaborative nature. As returns become more widely recognized and new investors enter the space, this collaboration may diminish, potentially to the detriment of the searchers. This model works so well as investors expect to and do a lot of ongoing work: mentoring, diligencing, connecting people, etc.. The success of the model has attracted more financial investors than operators, and some are unwilling to put in the hours to do the workneeded to help the searchers succeed.
On the searcher side, there is a risk that individuals may launch a search without fully understanding the challenges involved. For instance, if someone pursues a search because they did not receive a consulting offer after graduating from their MBA program, they may not be properly motivated. Resilience and grit are essential for success in a search. If it is too easy to raise the funds for a search, some prospective searchers may be less discriminating on which investors to include, and less motivated to do the necessary diligence to determine whether the model is right for them.
At Relay, we ensure that we partner not only with the right searchers, as mentioned previously, but also with the right investors and investment partners. We carefully assess cap tables, evaluate how collaborative partners will be, gauge their familiarity with the SF model, and determine how they will support the searcher(s), especially when challenges arise. The board is also a critical component of the SF model, though often overlooked (and since Board members are selected from the investor group, understanding the motivations and backgrounds of the full cap table is critical). For us, the board plays an essential role, guiding and assisting the searcher(s) throughout their journey, while also representing the interests of investors. The SF model is inherently collaborative, and at Relay, we are committed to maintaining that teamwork spirit.
