As awareness of the search fund model has grown, various alternative approaches have also gained popularity. The most recent is the Long-Term Hold model. The holding company Arbor Permanent Owners, inspired by Berkshire Hathaway, follows this approach with the goal of being a custodian of great Australian businesses and holding them forever.
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To start, can you tell us what Arbor Permanent Owners is and what makes it unique?
Arbor Permanent Owners is a decentralized holding company dedicated to acquiring and growing smaller, asset-light companies in Australia. Our primary focus is on “Great Australian SMEs,” which are market leaders in niche sectors, typically family-owned businesses with EBITDA between A$3M and A$6M.
What sets us apart is our long-term investment horizon. Unlike traditional private equity firms or funds of SFs, which often look to flip their investments within a few years for a quick profit, we aim to hold our acquisitions indefinitely. This means we approach each potential acquisition from an owner’s perspective, focusing on the sustainable, long-term success of the business rather than immediate returns. This philosophy allows us to acquire businesses at attractive multiples and avoid the intense competition from private equity firms.
Our playbook is straightforward: pay fair prices for great businesses, recruit and incentivize top-tier leaders, and reinvest cash flows into further acquisitions with modest leverage. We believe this strategy, guided by our north-star metric of ROIC above 20%, will lead to significant long-term success. Our edge lies in targeting acquisitions that are too small-scale, operationally unsophisticated, or long-term oriented for private equity, thus creating a niche where we can thrive without intense competition.
How did you come to adopt the German Mittelstand model as an inspiration for your acquisitions?
The German Mittelstand model is indeed a significant inspiration for us. Mittelstand companies are a group of SMEs in Germany, Austria, and Switzerland known for their stability, innovation, and resilience. These companies often have annual revenues up to €50M and are recognized for their ability to endure economic changes and turbulence.
Several key characteristics of Mittelstand companies resonate with our investment philosophy. Firstly, they are often family-owned and operated, fostering a deep sense of loyalty, stability, and long-term thinking. This familial approach is something we value and seek in our acquisitions. Secondly, Mittelstand companies excel in niche markets, often becoming global leaders in their sectors due to their ability to innovate and adapt to specific market needs. Thirdly, they have strong regional roots, contributing significantly to local economies and providing employment opportunities, which aligns with our goal of supporting and preserving local businesses.
Additionally, Mittelstand companies are known for their commitment to sustainability and quality, prioritizing long-term success over short-term gains. They also invest heavily in workforce training and development, ensuring a steady supply of skilled labor. By emulating these practices, we aim to build a similar ecosystem of Australian SMEs that are market leaders in their niches, deeply embedded in their communities, and committed to long-term success.
Your investment horizon is quite long, at 30 years. How do you manage investor expectations and liquidity?
Managing investor expectations and liquidity over such a long horizon is indeed a challenge, but we have developed a couple of strategies to address this. Firstly, we plan to offer annual “liquidity windows” starting in June 2030, where existing investors can sell shares and new investors can buy in. This model is inspired by SpaceX, which has grown to a significant valuation without publicly listing its shares by opening regular liquidity windows for secondary transactions.
During these liquidity windows, existing investors will have pre-emptive rights to acquire shares within our community before they are offered to new investors. This approach not only provides liquidity but also fosters a sense of community and continuity among our investors, ensuring that those who understand and support our long-term vision remain involved. Part of our role as Managers is to develop a secondaries market for investors. We plan to do this through sharing annual letters and financial performance.
Secondly, while our primary focus is on reinvesting cash flows to achieve high returns, we recognize that there may be times when there are not enough quality opportunities to meet our ROIC hurdle rate of 20%. In such cases, we will allocate capital to paying down debt or issuing dividends. Starting from Year 10, we plan to implement a formal dividend program to provide liquidity and returns to our investors, balancing the need for reinvestment with shareholder returns. This dual approach of liquidity windows and potential dividends ensures that our investors have access to their funds while we continue to focus on long-term growth and value creation.
How is your compensation model structured to ensure alignment with investors’ interests?
Ensuring alignment between our interests and those of our investors is crucial to our success. Our compensation model is designed to foster this alignment through a partnership.
Firstly, we don’t charge any management fees. Founders receive a Board-approved fixed salary to cover their salaries and administrative costs, ensuring that our personal financial stability does not depend on short-term gains. This model ensures that we only benefit when our investors benefit, aligning our incentives with long-term value creation and fostering a partnership mentality.
We are still finessing the “carry “ model, but it will be modelled off the typical economics seen with self-funded Searchers.
What are some potential challenges you anticipate, and how do you plan to address them?
Investing in smaller, private businesses comes with several inherent challenges. One of the primary challenges is the potential operational and market volatility. These businesses can be fragile and may require significant support to navigate market changes and growth opportunities. To address this, we conduct thorough due diligence before acquisition and work closely with the existing management teams to ensure a smooth transition and continued operational excellence.
Another challenge is maintaining liquidity for our investors given our long-term investment horizon. As mentioned earlier, we plan to address this through annual liquidity windows and a potential dividend program starting from Year 10. This approach provides our investors with opportunities to access their funds while we focus on long-term growth.
Lastly, preserving the cultural identity of the businesses we acquire is crucial. We believe that the success of these businesses is deeply rooted in their unique cultures and operational practices. To ensure this, we maintain existing management teams and operational structures, acting as custodians rather than imposers of change. This approach allows us to preserve the legacy and strengths that made these businesses successful while providing them with the stability and resources needed for continued growth.
By addressing these challenges with thoughtful strategies and a long-term perspective, we aim to build a portfolio of resilient, successful businesses that contribute to the overall economy while providing significant returns for our investors.
What was your experience with the SF model and your expectation with Arbor Permanent Owners?
Based on my experience in my accounting firm, we have been involved in many of the transactions that have occurred in the SF landscape. This extensive involvement gives us unparalleled knowledge of the deals that have taken place here – including valuations and terms. We have advised searchers on most of the financial due diligence, as well as many industrial or private equity players in M&A deals, so we have a deep understanding of these kinds of companies.
Regarding Arbor, we are currently raising A$25M to acquire our first target, a leading Australian manufacturer. Once we complete this first acquisition, our goal is to buy a second business within 18 months. We aim to manage at least 4 businesses in 5 years and continue growing from that point.
