A growing number of Accounts Receivable Management (ARM) service providers are receiving inquiries from a new type of potential purchaser. They are called search funds. These potential buyers are new entrants into the marketplace, but they are hungry and looking to purchase ARM service providers. What should you ask if a search fund makes an inquiry about your debt collection agency? What impact will these new buyers have on the industry?
Entities that can be categorized as search funds are approaching owners and executives in the ARM industry to purchase their businesses.
There are some complexity and nuance to these types of groups. One important question is what are these entities all about? What is the opportunity for owners/executives looking to sell an ARM service provider?
Typically, search funds consist of recent graduates who have come out of business school with the mindset they would love to immediately get into an owner-operator role. Instead of doing so organically, they are going out into the market and picking different industries with growth potential. One of these industries is debt collection. They are contacting owners/executives about investing in or buying the collections business.
The tricky part is these individuals aren’t coming to the table with a committed fund or capital. This is the biggest item debt collection industry owners/executives should realize before entering discussions with search funds.
All too often, there is the sense these individuals have a committed fund or capital, and following due diligence, they will be able to write a check from their fund to the owner of the business. This is not the case. These business school graduates are coming to the table with a concept of buying the debt collection company, relocating to wherever that business is headquartered, and jumping in after a transition to run the business.
In order for them to acquire the company, they will then do a capital raise from a group of high net worth individuals that had said we will back you in the event of a business transition. These high net worth individuals will then commit some form of capital. In addition, they will go to a lender – maybe an SBA lender, a hedge fund or mezzanine fund to raise the additional debt financing to acquire the business.
What they do is to take the equity received from the high net worth individual group and leverage it with debt received from an SBA lender or some other form of financing.
When these search funds reach out to an owner/operator, it doesn’t mean they aren’t real or legitimate. It is simply important for owners/executives in the debt collection industry to know what the playing field is and what it looks like in order to get a transaction completed. Search funds will need to bring in capital from an outside party in order to get the deal done.
What questions should you ask a search fund?
- Why are they calling you? You want to understand their knowledge base regarding the collection industry. Why are they interested? What excites them about the market? Are they aware of the regulatory challenges?
- Where is their capital coming from? Do they have their own pool of capital or do they have to raise it after they have done their due diligence and looked at the business? What is their overall structure?
- What do they wish to accomplish? Are they going to run the business from where it is presently located? Or do they plan to run the business remotely from where they are presently situated? Of course, this may not be feasible.
The answers to these questions will help an owner/executives of a debt collection company determine if it makes sense to pursue a dialogue with the search fund. While the people setting up search funds are highly intelligent and sophisticated, they may not be familiar with the debt collections industry. There may be some education necessary to get them interested in the deal.
Is the presence of search funds a good thing for the debt collection industry in that they see growth potential? Or are they vultures who see weakness in the industry?
Their presence is a good thing. A younger generation coming out of business school with new skills and knowledge; who bring in new thoughts, technology, views, and ideas, will benefit the industry.
It is important to remember it isn’t that there isn’t a deal that can be done with search funds. The deal has complexities and nuances the owner/operator must be aware of in order to not be blindsided when going through the process.
In order for a search fund to determine how much capital raise and debt financing may be needed to complete an M&A deal, the owner/executives must provide information to have a dialogue. The owner/executives will have to share more financial information to get feedback on whether the search fund can get an M&A deal done.
Client concentration can be an issue when initiating a dialogue with a search fund. Since they have to get a level of financing, client concentration can be an issue. For example, if one client represents 70% of revenue it will be difficult to raise the level of equity and debt sufficient to get the deal done.
CAS oversees and executes on M&A engagements, investment opportunities, compliance/regulatory assessments, valuation and expert witness litigation matters for constituents of the Outsourced Business Services (OBS) sector.
Has a search fund made an inquiry about your debt collection agency? Contact CAS Make this live to [email protected]