I started out doing LBO’s on an “ad hoc” basis. That is another word for “bootstrapping” which is another word for “I’m broke and don’t have access to capital”. I abhorred the idea of putting together a formal buyout fund, which seemed a daunting task, so I did my bootstrap deals with high leverage, partners and/or individual investors. Managing a horde of small investors, or a bunch of cranky institutional investors, didn’t seem like my ultimate lifestyle business.
The deals we look at are not comparable to private equity. We aren’t doing megadeals and buying big divisions of public companies. What I do is more along the lines, in size and scope, of smaller venture capital companies or seed capital funds. These small market funds now enjoy the presence of various crowdsourcing and crowdfunding sites for what they’re worth. So venture capital funds and other such capital seekers (aka LBO funds) now have an avenue to finance the small deals, and start small funds, that wasn’t always there.
I have always kept the door open to idea of taking on investors through a “pool” or LP partnership structure. However, I have never thought much of the big venture capital business model. It is a hit-and-miss affair that requires the fund managers to hit an out-of-the-park home run once in a while to stay viable. If they manage to do that, and most don’t, the rest of their deals can crater and they still will remain afloat.
While perusing today on one of the new funding sites I have looked at, it occurred to me that business buyers should once again look at the opportunities for starting small LPs (limited partnerships) to fund their deals. What sparked my interest is that there were so many Venture Capital opportunities startup funds in the small markets and virtually no LBO funds or anything of the private equity ilk.
This peaked my interest further so I wondered just how well venture capital funds do in general. Here is what I found from Inc Magazine.
“…in May 2013, the average 10-year return for a venture capital fund was 7.4 percent–exactly the same as the Dow Jones Industrial Average and the Standard & Poor’s 500 indexes, which both carry much less risk than an investment in a venture fund. Not to mention the fact that an index fund doesn’t tie up an investor’s money for 10 years.”
This is what I always thought but was afraid to ask. The returns from VC’s, at least big ones, can be awful. That started me thinking about putting together a small LBO fund as a VC alternative. When I do deals myself the ROIs are off the charts. If I put $100,000 into even a small buyout I will usually get it back in salary the first year, having not done a whole lot inside the company.
Anyway that is just the tip of the iceberg. My point is that it may be time to rethink my fear of funds and start thinking that LBO’s, especially small ones, are a perfectly profitable investment alternative to VC funds – which should make them marketable to investors, now more than ever.
The main advantage, if you didn’t like the astronomical ROI, is the immediate cash angle. I can pay the investor a very healthy and immediate cash payout as part of the deal. Cash-on-cash return it’s called and my deal has the cash flow to pay it. Can the seed capital fund say the same? Probably not.
The only problem with the fund angle is this. For the fund to have a superior return, it has to be fully invested, pretty much all of the time. This is something the VC’s have an easier time with than private equity. Startups want the money today whereas business sellers aren’t even sure they want it at all. Thus if I run out and raise a $10 Million fund, it had better be in stages to allow for the time factor in closing deals.
