Two Harvard professors compare two ways to buy small businesses: funded search (using investor money) and self-funded search (using your own money). They favor self-funded: buy at 4x earnings, use 80% debt, target 35% annual returns, with low risk because cash flow quickly pays off debt. No specific stocks or funds recommended; only teaching examples like Nashton Partners.
Harvard Business School professors Rick Ruback and Royce Yudkoff noted in the program that the core principles of Entrepreneurship Through Acquisition remain highly relevant today. The search fund ecosystem has become bifurcated: funded searchers target larger companies, while self-funded entreprene
Harvard Business School professors Rick Ruback and Royce Yudkoff spoke again after nearly a decade to discuss the evolution of the search fund ecosystem. Core theme: a clear divergence has emerged between funded searchers and self-funded searchers. The former have moved upmarket into larger transactions (average enterprise value around $20 million), while the latter have achieved striking returns in smaller businesses (below $1 million EBITDA). Royce Yudkoff estimates that self-funded searchers can acquire businesses at 4x EBITDA with 80% leverage financing, targeting a 35% investor return, while the searcher retains 60–70% of common equity — "the magic is in the multiple" rather than growth.
Rick Ruback notes that the search fund ecosystem has clearly diverged, with the two types of searchers exhibiting sharply different strategies and risk-return profiles.
Funded searchers target businesses with an average total enterprise value of roughly $20 million and EBITDA multiples in the 6–8x range. They compete directly with strategic buyers and private equity, placing them at a cost-of-capital disadvantage, which has significantly increased the risk of "not finding" — rising from the historical ~1/3 to over 50%. Stanford University tracking data show that funded searchers' investor IRR is around the low 30%, still far above large-cap PE (low-to-mid teens), but Royce Yudkoff believes these numbers are slowly trending downward. Funded search is becoming more like venture capital than private equity — a few star deals lift aggregate returns, but failure rates are higher.
Self-funded searchers, by contrast, target smaller businesses: EBITDA around $600,000–$1 million, with entry multiples of just 3–4x. They use SBA loans (up to $5 million for U.S. citizens, government-guaranteed) to finance 80–90% of the deal. The "not finding" risk is below 25%. Royce Yudkoff breaks down the math: at 4x entry, the asset-level return is about 25%; with 80% leverage and 8–10% debt cost, equity returns become "astronomical." The target investor return is set at 35%, and the searcher retains 60–70% of common equity. The key is that the extremely low entry multiple means even if operations underperform, the cash flow yield can quickly repay debt, greatly reducing the risk of principal loss.
Royce Yudkoff emphasizes that the core advantage of self-funded search lies in "the magic is in the multiple" — the extremely low entry multiple provides investors with a substantial margin of safety and return potential.
| Dimension | Self-Funded Search | Funded Search |
|---|---|---|
| Target EBITDA | $600k–$1M | ~$2M |
| Entry Multiple | 3–4x | 6–8x |
| Leverage Ratio | 80%+ (SBA loans) | Lower |
| Target Investor IRR | ~35% | Low 30% |
| "Not Finding" Risk | <25% | >50% |
| Investor Principal Loss Risk | Very low | Relatively high |
Rick Ruback adds that investor losses in self-funded search are extremely rare. "In the spread market, even if things don't go well, the cash flow yield rapidly repays debt, greatly mitigating downside risk." Royce Yudkoff further notes that, unlike funded search, the return profile of self-funded search looks more like traditional private equity — most deals consistently generate 3x, 8x, 10x MOIC, with occasional 1x, but the pattern is orderly.
Rick Ruback and Royce Yudkoff list the key screening criteria they teach students, the most counterintuitive of which is: growth is not on the list.
1. Low customer and supplier concentration: Avoid dependence on a single customer or supplier.
2. Recession-resistant: Mismatched with financial leverage; prioritize necessity or service-oriented businesses.
3. Manageability: "If you're allergic to cats, don't buy a pet store" — the searcher must choose an industry they can learn and handle.
4. Geographic suitability: The new generation of searchers generally values where they live, and the professors emphasize that remote management is unrealistic for a young CEO — "buying a company in Mississippi while running it from a ski condo in Colorado is absurd."
5. Asset-light: EBITDA nearly equals free cash flow; capital allocation decisions are episodic (e.g., acquisitions, new product lines).
6. "The business is a business, not a job": Avoid companies that rely on the founder's personal relationships or skills; ensure the business can operate independently.
Key insight: No single company meets all criteria simultaneously. The professors train students to develop judgment by "immersing them in deal flow," learning to assess "how good is good enough." In a recent classroom exercise, 100 targets were screened by 14–15 student groups, ultimately selecting roughly 12 different companies with no consensus — "beauty is in the eye of the beholder."
Rick Ruback shares practical experience on improving the probability of closing a deal, focusing on process management and pricing cushion.
Wednesday meetings: Work on promises from the previous week Monday–Tuesday, communicate progress Wednesday, and execute Thursday–Friday. This builds discipline and trust.
Pricing safety margin: This is the most emphasized lesson from the professors. In small business transactions, due diligence almost always uncovers "surprises" — incomplete contracts, missing licenses, unpaid taxes, stagnant employee salaries, etc. If the searcher has already stretched to the limit on price, the only option is "go back and ask for a reduction," but the seller has already mentally spent that money (vacation home, yacht, world travel), leading to deal failure. "Every deal needs to leave enough room to absorb surprises from due diligence."
Royce Yudkoff adds typical "red flags": Multiple owners selling together (especially when ages differ significantly, a younger owner may back out), owner's personal expenses as a percentage of EBITDA too high (above 50% signals moral hazard, the buyer has a severe information disadvantage).
Rick Ruback notes that the first year after acquisition for a searcher is typically 5–10% worse than expected, but year three is the truly good year.
Reason: Sellers often sell in a good year, the buyer's attention is distracted during the transition, and the business naturally degrades slightly. In year one, the new CEO is busy learning the business, meeting customers, and solving legacy problems, making it difficult to immediately implement improvements. It is not until year three that they truly understand customer needs and can launch effective service lines and growth plans.
Royce Yudkoff cites Will Thorndike's research, noting that most searchers sell too early — successful businesses continue to compound in years 7, 8, 10, 12. But the primary reason searchers are forced to sell is capital allocation issues: they have 95% of their net worth concentrated in a single business. Although the company is performing well, the personal risk concentration is so high that they choose to sell and cash out in years 5–6, which the professors generally consider premature.
This section does not apply. The original text does not discuss positions or directions of specific investable targets; it only uses teaching examples (Nashton Partners, Capital Digital, Brian Bonk) to illustrate principles, without any investment actions or attitude judgments.
1. Royce Yudkoff Judgment: The mathematical magic of self-funded search lies in "4x purchase, 80% leverage, 35% return rate". Support: Buying at 4x EBITDA means a 25% return on assets; after layering on 8-10% debt costs, the equity return is "astronomical," and the searcher himself retains 60-70% of the common stock.
2. Rick Ruback Judgment: The "failure to find" risk for sponsored search has risen from 1/3 to 50%+. Support: These searchers directly compete with strategic buyers and private equity, suffer from a significant cost-of-capital disadvantage, and deal sizes are larger (average $20 million enterprise value).
3. Royce Yudkoff Judgment: The risk of principal loss for investors in self-funded search is extremely low. Support: The very low purchase multiple provides a margin of safety; even if operations underperform, the high cash flow yield quickly repays debt, similar to traditional private equity rather than venture capital.
4. Royce Yudkoff Observation: The lower middle market is "the only industry where the best competitors leave every year". Support: As top investment managers' assets under management rise, they naturally move up to larger deals, leaving room for new entrants, making the opportunity set "evergreen."
5. Rick Ruback Advice: "Leave enough room in your bid to absorb due diligence surprises". Support: In small business transactions, "surprises" in contracts, licenses, taxes, etc., are frequent. If there is no room in the bid, the only option is to lower the price, but the seller has already mentally spent that money, and the deal inevitably falls apart.
6. Rick Ruback Judgment: The first year post-acquisition is typically 5-10% worse than expected; the third year is the real good year. Support: Learning the business, meeting customers, and solving legacy issues take time. Only in the third year does the CEO truly understand customer needs and implement effective growth plans.
7. Royce Yudkoff Judgment: Most searchers sell too early; successful businesses compound through years 7-12. Support: Will Thorndike's data shows this, but because searchers have 95% of their net worth concentrated in a single company, personal risk forces them to cash out in years 5-6, which from an investor's perspective is too early.
8. Rick Ruback Observation: Searchers "don't buy software companies; they buy software for software companies". Support: They buy software that serves small clinics, small city halls – markets that are stable and not easily disrupted, rather than social media or the latest apps.