In this interview, Brendan Mullen of Secha Capital introduces us to the concept of Search Funds, the rapidly growing alternative to Private Equity and Venture Capital. Focused on supporting young entrepreneurs keen to get their teeth into an existing small businesses, they leverage funds and energy to deliver vastly superior returns from small businesses.Â
Mullen says this little-known investment model is perfectly suited to solving the management gap in SMEs and can also produce multiplier effects: a Search Fund, or “entrepreneurship through acquisition” delivers not only outside capital, but also the self-confidence and self-reliance of local business people.
A Search Fund is a vehicle for young, aspiring entrepreneurs to raise funds, search for, acquire, manage, and grow an established SME and are increasingly popular in the US and Europe. They deliver superior returns (5x increase in the profits of his portfolio of businesses) and address four key components of our economic ecosystem:
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1) Entrepreneurs: A Search Fund is a low-risk path for entrepreneurship and management skills. It’s a viable alternative for Africa’s best, young human capital to bypass corporate life and to instead gain skills by growing a local business.
2) SMEs: “Searchers” do not acquire start-ups, they invest in “boring”, fragmented industries – the heartbeat of the economy – that is often ignored by private capital. SMEs need growth capital, but they also need high-powered human capital and this vehicle creates a shortcut bridge to accessing this talent. Also, these are the companies that create local, reliable jobs!
3) Financial returns: The Search Fund asset class does not require “unicorns” and it does not invest in winner-take-all industries. Instead, it encourages “Zebras” in industries where we already have precedent for listings and strategic acquirers.
4) Cost and scale-ability: The money raised for a Search Fund goes only to the aspiring entrepreneur or the SME. It’s a small amount, slightly larger than what we define as “angel investing”.
Mullens reckons the Search Fund asset class has not made its way to Africa because it does not fit with institutional capital providers’ mandates; the check size is too small and too diffuse. But when you strip away all the finance jargon and the Search Fund is the most natural of transactions: Someone invests in your business, then they work with the business to grow it.
He was interviewed on this week’s episode of Rational Radio.
Brendan Mullen joins us now. He sent me a mail a couple of weeks ago after the World Economic Forum Africa summit to say something really good is going on called “Search Fund”. It’s another model of investing. It’s different from venture capital, private equity, normal investing and I guess even different from impact investing. Let’s just go back a little bit. You co-founded a company called Secha Capital – you’re the MD – where did you come across this “Search Fund” concept?
Thank you very much for the time Alec. I felt compelled to reach out after reading about a lot of the new innovative ideas coming out of the WEF. Importantly, a South Africa focus on tech investment in the Fourth Industrial Revolution. I humbly suggest that Secha Capital is about getting back to the basics of investing. It’s a more natural type of investing. That’s really the Search Fund Model. So the Search Fund Model is very popular in the US and increasingly in Europe. It’s generally when a smart young person from McKinsey, Bain – where I used to work – or an MBA wants to become a CEO early. It’s referred to as entrepreneurship through acquisition. You raise a little bit of capital and you go find a company to buy, it’s often in boring fragmented sectors, maybe family run and it’s doing all right. You then apply your MBA skills to increase margins, do a little bit of marketing to increase revenues, upscale the team and a few years later you sell it off at a higher valuation. In the interim of course, you’re creating jobs, up-skilling the management team and creating financial returns. We hear a lot about the various tech investments that are getting front page news and that is great. But what I contend is let’s utilise this Search Fund Model – because I think it’s actually a much better fit for sub-Saharan African – than a lot of the other models that we copy and paste from Silicon Valley in the US.
I really like this from a South African perspective – given that many people are emigrating – and you would presume a lot of these people own businesses they want to get out of. Businesses they’d like to get a partner in, someone to go in there and rejuvenate it. Are you seeing that the demand is being met or that there’s sufficient supply?
So I think that’s a great question. It’s a two sided market. There’s a duality to this additionality. It’s entrepreneurship through acquisition or entrepreneurship through the investor operator model. But to answer your question, it is yes. South Africa’s best and brightest are not going into entrepreneurship. They’re not going into SME’s. They cannot afford to attract, retain and develop these best and brightest – the UCT/Wits grads – because of multinationals that are here, the KPMG and Bains of the world. That’s where people are excited to go. But what if we give them a route to entrepreneurship that’s lower risk, doesn’t require a ton of capital and they too can become entrepreneurs. So that duality of developing an entrepreneurial ecosystem and developing the SME ecosystem is win, win for the the entrepreneur and for South Africa.
So what kind of numbers are you talking about, how much is typically lent to the entrepreneur who’d be using this capital to invest in a business they’re going to be working in?
It varies. R5-10m would be plenty to buy a majority stake in an SME. At Secha Capital we’re kind of a Scaled Search Fund an Accelerated Search Fund. So we don’t take ownership stakes but we take minority stakes. Our first fund is very small for “private equity”. It’s a R50m fund – we’ve invested in six companies to date, we’ve increased top line on average 5x, margins are increasing and we’ve created 70 jobs – and thats just over 3 years.
5X is five times?
That’s where the opportunity is. This large pipeline of SME’s that are otherwise ignored by your more traditional capital providers. Again, when we copy and paste a private equity buyout model from the US – with a billion dollar fund in South Africa – that limits the amount of companies that you can invest in. Generally the people working for your fund look like me – maybe 10, 20 years older – they’re white guys, grey hair and they’re dealmakers. What I’m saying is let’s do more Search Funds. Let’s get younger entrepreneurs in there and let’s increases the diversity of people in finance and develop these management skills.
What kind of people typically are taking up those opportunities? Those six companies that you’ve invested in, what kind of profile person has gone in there?
So, what our model is at Secha – founded by classic profile MBA’s – is we’ve recruited younger people into these companies where they serve temporarily as Chief Operating Officers. So right now we have Yusuf Shaikh – who is a UCT grad who worked at BCG, now working at Hair City – our fifth investment. We have Kuhle Mnisi who graduated with a master’s from UCT. She interned at Goldman Sachs and now she’s the Chief Operating Officer for Rush Nutrition. So these are high calibre – some of the best and the brightest of South Africa – who otherwise wouldn’t be working for an SME doing R20m, R30m, R40m a year top line. They’d be going to the Goldman Sachs. Our platform has been a kind of a shortcut bridge to get this high powered talent to work for SME’s and help solve that management gap. When you get the best and the brightest of South Africa’s youth with the grit and the sector knowledge of the existing entrepreneurs – SME owners – that’s where the magic really happens.
It’s amazing. Many South Africans feel the economy is falling and people are emigrating and the skills are leaving the country. Something like this shows that’s not actually the case.
I echo your optimism. If you look at it from a returns and index perspective, you could see it as a kind of financial and human capital arbitrage. As I said, the average UCT/WITS grad is not working at an SME. So if you can go into these markets that are fragmented, that are ignored, that are boring and you work with the existing entrepreneurs – who are already great – that’s where something truly great can happen. And again, I like the additionality of it. Native Child is our first investment – it’s natural hair care for black women. Because of Secha’s investment here, the money has stayed in South Africa, it may have otherwise been sent offshore. Every rand that’s spent on a Native Child product stays in South Africa, it stays in this ecosystem, whereas otherwise it may have been a Unilever or a L’Oreal product and it goes to Europe or the US. So I like this kind of additionality, this multiplier effect of this search fund model.
