We believe that a thesis-driven, industry-focused search not only increases your probability of acquiring a business, it increases the probability that you will find a high-quality business in an attractive industry.
This search strategy is rooted in a “go slow to go fast” mindset. By first confirming that an industry is attractive, you increase the odds that when you examine a specific business it has the right industry fundamentals in place. As one of the most successful entrepreneurs in Pacific Lake’s history once said, a good search is all about “industry, industry, and industry.”
But the industry-focused search is not for the faint of heart. Many searchers grapple with a key question: what is a “good” industry? The answer seems highly subjective and investors' thoughts on the matter can vary. Without some sort of framework, how can you have confidence that your time is well spent? How do you confirm that the corner of the economy to which you plan to commit your time and effort is, in fact, a good place to start?
After investing in hundreds of search funds, we believe we have such a model. We call it the Pacific Lake 4 + 1 Industry Search Framework.
What is the 4 + 1 Framework?
The 4+1 Industry Search Framework helps searchers explore and evaluate potential industries, niches, and sub-industries by prioritizing four characteristics that will meaningfully influence the success of your business.
Is the industry growing? As you explore an industry thesis, you will need to quantify recent and future growth trends. It is not sufficient to merely note an industry’s projected growth rate. You need to understand the key drivers of that growth and how market forces are causing industry expansion. Are existing customers spending more? Or is the customer population itself growing? Whatever the case, identifying underlying causes for growth is your first priority.
Is the industry big enough? When we talk about an industry’s size, we are referring to both its Total Addressable Market as well as its target density, or the number of companies operating in the space. While an industry-focused search often leads to looking at smaller sub-verticals and niches, you want to be confident that the space you are examining is big enough to provide enough “shots on goal” when reaching out to business owners. You also want to ensure that the industry is large enough that any company you acquire has ample room to grow.
Do the companies operating in the industry generally offer mission-critical services? Look for difficult to replace services. Attributions of desirable search fund businesses – high margins, low churn, and contractually recurring revenues, to name three examples – are derivatives of a company’s ability to offer high-value products and services to its customers.
Does the industry have a large number of underserved customers? Penetration is the most commonly underrated industry characteristic by searchers. An underpenetrated industry can be a fantastic place to buy a company, while a more mature space can present obstacles to growth. In many cases, penetration (or the lack thereof) goes hand in hand with industry growth.
And last, but certainly not least, the Plus One!
The presence of high-quality business models
An industry can have fantastic fundamentals, but if it does not contain business models attractive for a search fund entrepreneur, it possesses little value for you. Thus, the last element of the Framework is the “Plus One”: the requirement for any industry you are examining to contain B2B models, recurring revenue, and high margin services businesses. As you are exploring an industry, you will want to periodically confirm that its companies have business models that fit your search criteria.
How do I use it?
We designed the 4 + 1 Industry Framework to be used as both a compass and a rubric. It can help point you in the right direction as you explore an industry or even a broader economic sector. By deliberately and methodically looking for fundamentals like growth and product criticality, you drastically increase your chances of finding a good business. Periodically, you will want to evaluate a space that you have spent time understanding. At this point, the Framework serves as an assessment tool. Just how good is the industry you are exploring? With the 4 +1 Industry Framework, you will always have the answer.