Royce Yudkoff and Rick Ruback – REALLY Private Equity

**Patrick O'Shaughnessy** (0:00)
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Hello and welcome everyone. I'm Patrick O'Shaughnessy and this is Invest Like the Best. This show is an open-ended exploration of markets, ideas, methods, stories, and of strategies that will help you better invest both your time and your money. You can learn more and stay up to date at investorfieldguide.com.

**SPEAKER_2** (0:59)
Patrick O'Shaughnessy is a Principal and Portfolio Manager at O'Shaughnessy Asset Management. All opinions expressed by Patrick and podcast guests are solely their own opinions and do not reflect the opinion of O'Shaughnessy Asset Management. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of O'Shaughnessy Asset Management may maintain positions in the securities discussed in this podcast.

**Patrick O'Shaughnessy** (1:21)
In this episode, I continue to pull on one of the most interesting threads that I have uncovered in the course of producing this podcast, the world of permanent equity. My guests today are Royce Yudkoff and Rick Ruback, two Harvard Business School professors who have partnered to create a popular class that teaches students how to search for, acquire, and run a small business directly after graduation. The course is aimed at students who want hands-on management experience as soon as possible. After purchase, there is no timetable for selling the business. Indeed, if done well, there is never any reason to sell because the free cash flow yields to owners are higher than most alternatives.
I approached this conversation from an investor standpoint. LP investors usually partner with these searchers to form what is called a search fund. A search fund allows recent MBA grads to spend time looking for a business and ultimately acquire it. The result is small in scale, but is often a high return proposition for investors.
I loved our discussion on what to look for in a business and what to avoid. The principles we list are useful for investors of any kind and will be particularly appealing to those from the buy and hold, value investing, or quality investing camps.
One point of note, which wasn't captured during the recording. One of the reasons this style of investing isn't more well known is that it's extremely expensive upfront. It can take years to find a company and once found, the transaction costs can be 20% of the total purchase price. As you'll see, Rick calls this category really private equity. If you enjoy this conversation, be sure to check out Royce and Rick's book, The HBR Guide to Buying a Small Business, which goes into many of the topics we cover in even greater detail. For show notes on this episode, visit investorfieldguide.com forward slash HBS. And now, please enjoy this conversation with Royce Yudkoff and Rick Ruback.
Royce and Rick, thank you very much for taking the time with me today to discuss a topic that is still relatively new to me. Probably discovered it just three, four months ago. But I think from an investor standpoint and also from an operator standpoint is a really ripe and interesting niche in the world of investing, which is that of search funds. Maybe we could begin by you describing, pretending that I'm an LP, looking for interesting things to do with my capital. Sort of explain at a high level the idea behind a search fund and why both recent MBA grads but also LP investors might be interested in this concept.

**Royce Yudkoff** (3:47)
This is Royce. I'll take a crack at it, Rick. I know you'll jump in whenever you see fit, but maybe the idea starts with the investment opportunity, which is across North America, there are hundreds of thousands of small businesses, which Rick and I think of as businesses with anywhere from $750,000 to $2 million of EBITDA.
And these businesses often have founders who need to retire.
The businesses are enduringly profitable, successful small firms, but there's no natural successor. And that founder needs someone who can organize a purchase and then run it as CEO. And that population is much smaller than the population of people reaching the end of their careers in these small firms. And for that and other reasons, these interesting, enduringly profitable businesses sell for around four times EBITDA. That's an amazing opportunity for an investor to buy a business that is very high quality, enduringly profitable, and trades at four times EBITDA.