The J-Curve in SF Investments: from initial decline to upward growth

When a searcher acquires a company, the J-Curve in SF investment reflects the financial and operational trajectory of the newly acquired business. This phase marks the transition from search to acquisition and value creation. The curve typically evolves through three main stages:

1/ Acquisition & transition (deeper dip in the J – initial decline)

Initial impact on financial performance:

• Acquisition costs (DD & legal fees, transaction fees, debt financing costs) create an immediate negative cash flow.
• Integration challenges and initial operational disruptions can temporarily affect business performance.
• Searchers often need time to build credibility with employees, customers, and suppliers, which can slow initial momentum.
• New costs: The company often assumes board and audit costs for the first time.

Previous owner impact:

• Actions to maximize EBITDA: It is common for sellers to maximize their sale price by bringing revenue forward, deferring expenses, and halting growth investments.
• Focus on the sale process rather than the business: Negotiations for the M&A process can take months, often to the detriment of day-to-day operations.

Leadership transition risks:

• The outgoing owner’s departure may create uncertainty among key employees or clients.
• The new CEO (searcher) needs time to understand the business, build a leadership team, and execute a strategic plan.

Investor Perspective:

• Investors typically see a dip in returns as expenses increase and the business undergoes a transition period.
• As acquisition financing generally includes debt and earn-outs, early cash flows may go toward servicing debt rather than growth.

It is completely normal for the acquired company to experience an initial drop in value during the first year due to a temporary decline in EBITDA. Generally, a 10-15% EBITDA reduction is acceptable.

2/ Stabilization & early wins (inflection point)

Operational improvements:

• The searcher identifies inefficiencies and implements process improvements, cost optimizations, and strategic initiatives.
• Hiring key executives, introducing performance metrics, and improving sales strategies can start yielding small but visible gains.

Cultural & leadership adjustments:

• Employees adapt to the new leadership style and strategic vision.
• Retaining and motivating key personnel becomes a priority.

Financial recovery:

• Revenue stabilizes or grows, and profitability begins to recover.
• Debt repayment becomes more manageable, and investor confidence strengthens.

Returns may remain flat or slightly positive during the second year as integration and transformation take time. This is the critical period when the acquired business transitions from stabilization to growth.

3/ Growth & value creation (steep upward curve)

Expansion & scaling:

• The company experiences sustainable revenue and profit growth (double-digit growth).
• The searcher executes strategic initiatives such as geographic expansion, digitalization, new product launches, or pricing optimization.
• Growth through acquisitions.

Increased valuation & múltiples:

• If the company grows profitably, valuation multiples expand, leading to increased EV.
• Investors begin seeing strong returns as cash flows improve.

Exit or long-term hold:

• After 5-6 years, the company should be well-positioned for an exit via a strategic buyer, financial buyer (private equity), or recapitalization.
• This phase delivers the highest returns (30-35% expected IRR), marking the success of this asset class!

Patience is key in SF investments. The focus should be on long-term value creation. The depth and duration of the J-Curve depend on how effectively the searcher transitions into leadership, stabilizes operations, and executes a growth plan.