Summary

Jason Ehrlich from FruitionCap discusses the fund's mission to support self-funded searchers in acquiring and operating businesses. The conversation covers topics such as deal structure, financing, due diligence, target industries, operator qualifications, and investor expectations. FruitionCap focuses on enduringly profitable B2B businesses and aims to provide stable returns with a risk-adjusted approach. The fund offers strategic guidance to operators and holds a minority stake in the acquired businesses. The chapters provide insights into the fund's investment criteria, deal evaluation, and the importance of aligning with the right operator. The conversation covers the concept of the step up in private equity and venture capital deals. The step up is a sweetener for investors, providing them with additional financial benefits when their shares convert from preferred to common. The typical range for a step up is between 1.5 and 2 times the initial investment. The episode concludes with the host thanking the guest and providing contact information for further inquiries.

Takeaways

FruitionCap supports self-funded searchers in acquiring and operating enduringly profitable B2B businesses.
The fund provides financing through a combination of debt (typically SBA loans) and equity investment.
Deal evaluation includes financial analysis, due diligence, and consideration of working capital.
FruitionCap seeks operators with key skill sets, such as leadership, P&L management, and strategic vision.
Investors in the fund can expect stable returns with a risk-adjusted approach.

 

Watch the Interview:

Transcript:

Jon Stoddard (00:00.514)
Welcome to the top M&A entrepreneurs. Today, my guest is Jason Erlich from FruitionCap It's a fund to help self-funded searchers finance the acquisition of a deal. So we're gonna talk about that. But before we do, if you like this type of content, please hit the bell and the subscribe button. Well, welcome to the show, Jason.

Jason Ehrlich (00:25.202)
Hey Jon, thanks for having me. Glad to be here.

Jon Stoddard (00:27.03)
Good, I really wanna talk to you about this, this fruition cap, fruitioncap.com came on my radar recently so I wanted to ask you about that. First of all, let's talk a little bit about Jason. Who is Jason, where does it come from and why did you start this company?

Jason Ehrlich (00:45.298)
Yeah, sure thing, John. So I'm the kind of lead partner over at Fruition Capital. There's a few others that have been around the ETA and search space for a number of years, in addition to myself. My background kind of comes from various sort of corners of the alternative asset investment space, most recently and most notably commercial real estate. So I founded my first investment firm in that space, specifically around multifamily.

around six years ago after sort of investing as an LP, as a passive investor myself for a number of years. And in the last six or so years that I've been running that as a general partner, I've continued my own sort of LP investments in other alternative asset classes, you might say, and within the last year or so came into this ETA, this searcher community in a really strong way and got to know it quickly, got to love it quickly.

The search fund side of the world was pretty mature, but that the self-funded search side was growing like crazy, was still the Wild West, and really had a need for what we were trying to put together, which was a fund and a firm to support self-funded searchers, to write bigger checks, to be able to provide more ongoing support to those searchers that we worked with. So we kicked off Fruition Capital, and here we are.

Jon Stoddard (02:04.642)
When you say excited, when you refer excited, you're talking about the returns that it could offer an investor?

Jason Ehrlich (02:12.246)
Well, it's far beyond that. I mean, I am a big believer in small businesses like the backbone of the American economy and it feels almost a little cliche to say, but when you look at the numbers, it's absolutely true. So yes, I think the financial returns are tremendous, but I also think the opportunity in supporting individual entrepreneurs to sort of facilitate this ownership transition as you have boomers holding a majority over half of businesses in this kind of segment we're talking about retiring.

keeping these businesses in private hands, keeping the jobs in the community is really important for us as a country. And so we're very happy to contribute to that, in addition, of course, to making strong returns.

Jon Stoddard (02:50.842)
Yeah. So let's kind of talk about what that type of deal would look like. So first of all, I'm at your website called FruitionCap and you're going to allow the self-funded searcher. Well, so tell me the difference between an independent sponsor and a self-funded searcher so people understand that.

Jason Ehrlich (03:09.51)
Sure. So a self-funded searcher is someone who is going to go out there and find a business for themselves to own and operate. They're going to foot the bill for their search and the transaction costs. They personally guarantee the loan in most cases when they're taking down a deal. Usually, they're looking at businesses in the half of a million to $2 million in EBITDA kind of range.

And the economics for their deals are a bit different from what an independent sponsor might do. Independent sponsor is looking probably at a little bit bigger deals, and they tend to do a whole series of these types of deals where they put operators in place. They don't necessarily retain full ownership of the deal, and they're certainly not in there running the business day to day. Self-funded searchers traditionally are taking it down, buying it, operating it.

Jon Stoddard (04:03.326)
Yeah. Could they put somebody in that role? Yeah. All right. So how do they retain full ownership up to 80%? That's one I'm looking at your website says, we're your investors, not your boss.

Jason Ehrlich (04:06.335)
Oh, of course. Yeah.

Jason Ehrlich (04:17.162)
Yeah, that's true. So that's really in comparison against traditional search funds, right? Because if a, let's say a recent MBA grad or anyone really who wants to go down the route of a traditional search fund, they'll get paid a salary for a couple of years from that search fund while they're searching, they don't have to worry about personally guaranteeing the debt or raising the equity, but when they acquire that business, the search fund will retain like 70% ownership and therefore full control. So at that point.

the searcher becomes more or less a paid CEO, which I'm not knocking, that's great for some people. Obviously that route's held a lot of success. The folks that we're working with, the folks, yeah, I mean, you can be fired from the business that you went and bought. And the folks that we work with really wanna be true owner-operators. They don't wanna necessarily be answerable to anybody. They want the autonomy.

Jon Stoddard (04:55.734)
but you're in the hot seat. But you're in the hot seat if you're not performing, right? Yeah.

Jon Stoddard (05:04.512)
Yeah.

Jason Ehrlich (05:13.954)
And our model is set up to respect that, to be able to have a board seat, be able to have visibility and add value where appropriate, but we're never going to put ourselves in a position where we have authority over the searcher. That's just not our model. That's not what self-funded search is all about.

Jon Stoddard (05:30.902)
So are you coming in, can you tell me what that piece of the pie looks like? Is it skin in the game from the searcher? Is it funds from you guys? Is it earn out, seller financing, and some bank debt? Kind of like a private equity fund would do, like a searcher? Yeah.

Jason Ehrlich (05:48.043)
Yeah.

Yeah, the typical self-funded search deal structure involves mostly debt. I'll say around 80% typically, sometimes higher than that. Most commonly we're talking about SBA debt. If it's a larger business, you know that some banks will do a second loan on top of that with concurrent current terms, Harry Patsue loan, if you're familiar with that terminology. Some conventional debt in here, but I would say we see probably 75% SBA loans used. There's...

almost always some sort of seller carry that goes along with that SBA loan, and then the rest is equity. And most searchers either can't bring the amount of equity needed or don't want to. They're already having enough exposure to one deal, so they'll go out and they'll raise some external equity. And that's where our firm and our fund really comes in is, let's say our sweet spot is settling out in that million and a half to $2 million EBITDA. You might be raising...

about that amount in equity to facilitate the deal. And so we'll come in and we'll write a single check in the 600 to 800k range, which takes a lot of the stress out of the raise and kind of enables that searcher to go to other investors and say, hey, I've got an anchor investor. They've already been through all the operating agreements. They've diligence the business. Do you want to come in and invest alongside of them?

Jon Stoddard (07:09.418)
Yeah, let's kind of talk about specifics and just anchor on a specific example. Like it's doing 5 million top line and 1 million bottom line. What kind of company, how much due diligence do you dive into? Because here's what happens a lot of times. Self-funded searchers, they'll get the SIM, they'll get the financials, and the business broker, he boosts up the SDEs and hey, there's a million dollars here, but...

It's not really a million dollars. What are you looking for? Like the threshold debt service coverage ratio debt to equity kind of. To pass what you're looking for.

Jason Ehrlich (07:46.998)
Yeah, as it relates to the financials, I mean, we always will want to see a third party Q of E. And we don't have to have our own done. Q of E is quality of earnings for anyone not familiar with the acronyms. I know we speak in acronyms a lot. A quality of earnings report will go through there and have CPA firm actually audit the financials. And they will say, actually, these add backs should be disallowed and all that. So we'll want to make sure that the...

price that the operator's paying and the multiple that they're paying is not reflective of, you know, phantom income, for lack of a better term, income that shouldn't be included in that purchase price. And networking capital is a big important factor with that too. A lot of people, especially sellers in the lower side of the market, don't really understand how working capital plays as an important part of the business. So those are factors we want to make sure the searcher gets right up front. After that, you know, there's sure there's a series of ratios we want to look at.

debt service coverage ratio among them. We want to see something that's north of probably like 1.75. I think in this particular space, that's pretty common. I mentioned I come from real estate background. It's more like 1.25 there. But I think we see a lot more. That's right, a lot more collateral. And you see a lot more cash flow coming out of these businesses.

Jon Stoddard (08:59.014)
you have collateral. Yes.

Jon Stoddard (09:05.03)
Yeah. Um, I got to go back to a statement here and give me a second because I'm going to go back to this, but, uh, the working capital, or do you see, uh, a lot of these small businesses, they always want to take the working capital out. Are you, uh, are you favor against, uh, you know, SBA coming in and replacing the working capital or requiring the working capital to stay in the business? Cause yeah.

Jason Ehrlich (09:27.774)
No, in our view, working capital should always remain in the business. If it's not remaining in the business, the purchase price needs to be adjusted accordingly.

Jon Stoddard (09:37.203)
Right. Okay. So somebody brings you a great deal. It's 5 million top line, 1 million to bottom line. You go through a quality of earnings. Are we talking about a, you know, $15,000 quality of earnings person, like a top CPA firm or 30,000 or?

Jason Ehrlich (09:53.318)
Yeah, there's dozens of different firms that do them out there. And some firms will actually do more than just the quality of earnings. So one of the firms that we like to see, and we never dictate this to a searcher, right? Again, the searchers in the driver's seat will say, hey, if we're going to invest, we want to see a QOB done. Doesn't have to be from one of these top firms. And the same thing with the legal documents, right? You want to have competent representation there.

But you don't need to go pay a national firm. We're not talking about acquiring $100 million business. There are niche firms in our space that do this repeatedly and in a reliable way at a reasonable price. So one, I'll just mention one firm off the top that we like to work with is Guardian Due Diligence. Elliott Holland, I think they charge a very reasonable fee and they do more diligence than just the Q of E. It's more holistic, which we love to see their reports. So just one, a shout out.

Jon Stoddard (10:46.622)
Yeah, I've had, I have Elliot on. He's a good guest. Yeah. So when somebody brings you a deal and you go through these financials, is this the due diligence is out of the self-funded searcher's pocket or is that bundled into the

Jason Ehrlich (10:50.391)
Fantastic.

Jason Ehrlich (11:03.011)
So.

Yeah, most commonly self-funded searchers by the nature of self-funded, they're paying for these costs upfront, but usually they'll have some provision in the deal that will be able to recoup their costs that they've outlaid out of that.

Jon Stoddard (11:23.882)
All right, so let's say Elliot does a great Q of A and the customers say, we'll continue to keep buying from this searcher. You get the green light now. And does it already have, of course, we're into an LOI. Do you say that, I gotta go back a little bit because a lot of the times I've seen these self-funded searchers, they get ahead of themselves and offer a very high multiple to get the deal done.

Jason Ehrlich (11:53.654)
Yeah, I mean, we have a specific buy box, right? And if we are looking in this range of, let's say, two million, sub two million EBITDA, we're not gonna wanna see a multiple north of, let's say, 4.5, maybe five on the very top end if it's a $2 million business that has strong recurring revenue. If the multiple's north of that, the buyer's probably overpaying and it's not a deal we're gonna get involved in. We commonly see deals in the,

Jon Stoddard (11:53.807)
And it comes to you. Yeah.

Jason Ehrlich (12:23.094)
three and a half to four times range.

Jon Stoddard (12:25.45)
Yeah. And what kind of business is this? What niche sector is this for this buy box? Is it with boring businesses? Yeah.

Jason Ehrlich (12:29.63)
Yeah, I'm glad you asked. So our focus is exclusively on B2B companies. So we have this sort of enduringly profitable thesis that we subscribe to. So we're not looking for businesses that are a turnaround story that have been struggling. We're not looking for businesses that are on a crazy growth trajectory rocket ship thing. And we're certainly not looking for businesses that are so small that basically,

the entrepreneur is going to be buying a job more than they're buying an operating business. So B2B companies in that kind of north of a million EBITDA, we stay out of certain sectors where they're very cyclical, so no energy, no tech, no construction. These things are either highly cyclical or highly disruptible in the case of technology. So we're just looking for those old economy type businesses that are dealing with the same customers year in, year out, very stable revenue.

Jon Stoddard (13:00.362)
Right, right.

Jason Ehrlich (13:24.81)
We don't have a specific industry focus outside of the red flagged ones that I mentioned, and we don't have a specific geography. We actually like to get diversified on both of those sort of dimensions, geographically and by industry, as long as the business meets our sort of qualitative criteria.

Jon Stoddard (13:42.502)
Yeah, just United States or Canada too. I got a lot of Canada, Canadian friends watch this show.

Jason Ehrlich (13:45.282)
just domestically in the US. Yeah, we love you Canada, but unfortunately the legal structure of our fund is only set up for domestic investment at this point.

Jon Stoddard (13:54.667)
All right. Sorry about that. So this endurally profitable that's a key word there that came from, uh, Richard Ruback and Royce Yudkoff from Harvard. Yeah, there you go. This is that. Yeah, it's a great book. Pioneer small business.

Jason Ehrlich (14:02.678)
That's the HBR guide right there. Yes. If you haven't read it, read it.

Jon Stoddard (14:12.47)
HBR guide to buying a small business. These are the guys that started RB partners that kind of learned that, uh, well, it's difficult to go out to do searchers. Why don't we hire these ambitious kids to go find the searchers and bring us the deal flow. Yeah.

Jason Ehrlich (14:23.875)
Ha ha.

There you go. Now these ambitious kids are keeping 70% and they're owning it and it's life changing in terms of lifestyle and the potential for generational wealth. So they were onto something for those kids.

Jon Stoddard (14:38.327)
Yeah. So let's go back into this. What is defined an endurally profitable business? Are we talking about 5%, 10%, or 15% depending on the niche or sector?

Jason Ehrlich (14:48.886)
Are you talking about in terms of recurring revenue or what are those percentages?

Jon Stoddard (14:50.866)
Yeah, about recurrent, well, recurring revenue, one thing, but endurably profitable, like the EBITDA is 15%. And it's, you know, in, in market comparison comps, it's good or better.

Jason Ehrlich (15:02.994)
Enduringly profitable to me speaks to the fact that its EBITDA has been stable, its revenue has been stable or slightly growing for a long period of time. And you can point your finger at the reason why that is and why it should continue. So EBITDA will vary. Manufacturing has a certain band that it's within, service businesses have a band that's slightly higher. So I'm not going to just point at a given EBITDA level. We want to see EBITDA that's

sort of in line or above if possible with what that sector's doing. But Enduringly Profitable isn't about, oh yeah, your EBITDA margin is good. It's about you've been producing it in a stable way over time. You have the same people buying from you over and over again. And I can look at the business and I can say, okay, I see that you are a critical piece of this value chain. And I can see why you're, let's just pick one example of a competitive barrier here.

I can see that you're a really small piece of this big cost structure over here, but it'd be really expensive to sort of push you out and put somebody else in. So I can explain why they keep buying from you over and over again, and I have reasonable belief that that's going to happen into the future. That's enduringly profitable in my mind.

Jon Stoddard (16:21.686)
Yeah, let me give you an example and you make a call on this. It's an HVAC company doing $5 million in a very large metropolitan area to like Phoenix, it's year around. Everybody needs AC and heating and Phoenix because it's average temper is pretty high. So 50% of his business is a commercial B2B, but 50% is residential. How would you look at that?

Jason Ehrlich (16:46.334)
Yeah, so for our particular thesis, we're very B2B centric. So just with my own sort of fruition fund hat on, that's not a deal we're going to do because the residential mix is just too high. Now, can a business like that be enduringly profitable? Do you have a big enough base of commercial clients there generating enough revenue to where you can go out there and scratch and claw for the what I know to be very competitive retail business? You can.

It's just a little too far towards that B to C end of the market for us.

Jon Stoddard (17:20.798)
Yeah. Are you looking for some kind of threshold? Like 70% would be B2B and reoccurring?

Jason Ehrlich (17:25.942)
I'll say that everything we have now is pretty much exclusively B2B. When I say recurring, it doesn't necessarily have to be that your clients are on long-term contracts, but we see the same list of clients buying from you over and over, year after year after year, so your customer churn is very low. I think that if we had a business that was doing, let's say, 80% and they just had a small mix of B2C sort of in there, we would take that on a case-by-case basis, but mostly it's exclusive.

Jon Stoddard (17:54.11)
Yeah, let me ask you, for instance, back to that HVAC example. And one of the individuals I was talking about, I think he's already talked to you, but he had the acquisition that he has an LOI, has long-term commercial contracts, B2Bs with, you know, restaurants, fast food restaurants, et cetera. But it doesn't, it's not reoccurring revenue. He has maintenance agreements, maybe $500 a month.

with 40, 50, but it's not, it's reoccurring, but that's not a big portion of the revenue. It's when the freezer goes down, then he has to go replace it. And those freezers are very expensive. Yeah.

Jason Ehrlich (18:35.382)
Yeah, that's right. And so if you've got a business like that where because you've put in the actual recurring revenue, you have a relationship with them, you're their go-to provider and they're going to come to you when those big ticket items happen, that's my point, that can be enduringly profitable because that same customer, whenever the big ticket item does happen, they come and they buy from you.

Jon Stoddard (18:57.514)
Yeah. Let me go back to your list on your website and you talk about not cyclical, definitely understandable about that, but also, uh, or technology centric. So you're not touching technology kind of companies. And what the Warren Buffett used to say, I'm not touching technology cause I don't understand it, but he's got money into Apple and, uh, other companies.

Jason Ehrlich (19:06.615)
Yeah.

Jason Ehrlich (19:19.326)
Yeah, I guess his understanding is improving. Listen, it's obviously a vital sector of our economy. It has potential for explosive growth, right? But it is also highly disruptible. When you look at tech, few names are able to go out there and produce reliable earnings over and over and over again. There's a few giants, right? And they garner crazy multiples. I don't even want to know what Apple's trading at on a multiple basis. It's not four times. It's not four and a half.

Jon Stoddard (19:46.706)
It's probably 30, I think.

Jason Ehrlich (19:49.182)
Right. So for us, certain models, SaaS type models, they would check a lot of the boxes for recurring revenue, business clients, and all that. But they are subject to disruption. Tech is constantly changing, evolving. We're in the first inning of generative AI right now. And there's all this media attention about the jobs that it'll displace and all of that. I think about something like that could walk into.

a whole series of software-based, technology-based offerings and just make them obsolete with the drop of a hat. That's a sort of existential risk that we're not taking.

Jon Stoddard (20:32.094)
Yeah, there's a hundred million people use chat GBT every day now, which is crazy. Yeah. Less than a year. So let's talk about the operator. Who, who does this look like? I know it's a self-funded searcher. Uh, are you asking the self-funded searcher to bring their own skin in the game and what is that? How much is that?

Jason Ehrlich (20:37.002)
Yeah, and it's been out for less than a year or something like that.

Jason Ehrlich (20:47.133)
Yeah.

Jason Ehrlich (20:54.834)
Yeah, so let me talk about the operator, the entrepreneur first, and then we'll talk about sort of the structure with that. So we went through our business acquisition criteria, and that criteria is not really flexible as you probably got when you were poking it on a couple of dimensions. Our entrepreneur criteria is far more flexible. There are several key skill sets that you need to run a business, right? You've got to be able to...

Jon Stoddard (21:00.204)
Yeah, yeah.

Jason Ehrlich (21:19.89)
lead, manage, and inspire people. Because business, at the end of the day, it's people and systems. So you've got to have the people aspect of it. You've got to be able to manage a P&L end-to-end, because that's what a business is. You've got to have a strategic vision for where that thing is going to go. But you can get that from a lot of places. So we like to see people that have an MBA. We like to see people that have a decade or more of professional experience.

It's not all mandatory. We have people, operators that are, we've invested in them, they're in our fund, that meet those dimensions. And we have people that started and ran their own business, exited and are now doing another business. Well, guess what? I couldn't care less if you have an MBA. You've proven you can do what we're talking about. Or people that have been in a, let's say, it's kind of a corporate role, but they've managed people, they've been responsible for a P&L, we can get a comfort level from talking to them.

that they have what it takes to run the business. So it's a lot more subjective. A lot more people can do it. The second part of your question was, what does that look like? What do they need to bring to the deal? So certainly in the instance where they're personally guaranteeing the debt, SBA loans in particular, that goes a long way. We always like to see some kind of co-investment, but it can be.

sort of a token thing, we're talking about maybe $50,000 or something like that. If it's not recourse debt, if they're using some other provider and their name is not on the loan, then we certainly want to see much more significant skin in the game from an equity investment perspective.

Jon Stoddard (23:02.002)
Yeah. I got a question for you about that. You know, maybe even if it does meet the MBA, maybe he was a special operator and managing people in the services. Uh, maybe he was an executive, something like, did you ever get a sense what they, they know what the bell rings, but the, the personality clashes coming through these interviews that like, I'm just not going to have them in my, I'm not going to put them in front of my investors or.

Jason Ehrlich (23:26.47)
Oh yeah, no, that's why I talk about it. It's more subjective, right? We've got to be able to believe that this is someone who is a high character, high integrity person who's going to be good at working with people, employees and customers, because that's what it takes to succeed in business. And even if the resume looks good, if somebody is not coming off and exuding that vibe that they can do that, it's an immediate red flag. It's the side of our model that relies a lot more on your gut, and we listen to ours.

Jon Stoddard (23:55.262)
Yeah, do you do any background checks on the individual?

Jason Ehrlich (23:59.794)
Not formal, we're not engaging third parties to go digging through anybody's credit report, but we definitely like to talk to people. We definitely like to talk to people that have been in their sphere, whether it's people they've worked for, bosses that they've had. We like to get some points of reference to sort of triangulate on the character.

Jon Stoddard (24:07.554)
Criminal records. Yeah.

Jon Stoddard (24:21.862)
Yeah. All right. So you've got, let's say you have a great operator, self-funded searcher brings you a very nice deal and it checks all the boxes. Right. So is, yeah, it's a good day, right? And it's a good essential industry niche. And, you know, it's been around for 10, 15 years, whatever. And the guy wants to retire, you know, a reasonable multiple debt, great debt service coverage ratio.

Jason Ehrlich (24:33.463)
Good day.

Jon Stoddard (24:50.038)
So is this a fund that you guys have in like a bank account? You can write a check immediately, or is this a, you know, I've got to get this deck and the story out to a number of high net worth individuals in a net worth.

Jason Ehrlich (25:04.282)
No. So we operate through a fund model. We are raising the capital ahead of getting the actual deals done. So we're not going out with pitching each individual deck. We have the whole thesis that we've pitched. It's out there with our investor group, every investor. So I'll take off my sort of searcher-facing hat for a minute and put on my investor-facing hat. If I'm an investor who's thinking about accessing this asset class, I can write a single check.

and get immediate exposure to these six to eight deals that will put in each fund, right? And I'll get diversified across geographies and across industries. From the searcher's perspective, they don't have to go out there, at least not with us, because again, we don't take up the whole cap table. We like to be 40%, maybe 50% of a searcher's cap table. So they will have to still go out there with the deal-specific pitch deck and raise some additional equity. Again, we can kind of help with that. We have a network of folks that like to invest alongside us.

We are not taking that deck and going and pitching it. We have the capital lined up in the fund that we'll invest.

Jon Stoddard (26:06.678)
And what are you asking yourself for? How much are you on the cap table? You said 40 to 50%.

Jason Ehrlich (26:12.33)
The fund, we like to take up 40 to 50% of the cap table, the equity side.

Jon Stoddard (26:16.018)
Yeah. And are you any other preferred, is this preferred chairs and

Jason Ehrlich (26:21.194)
Yeah, we go along the same sort of standard terms that you see in the self-funded search space. So it's a participating preferred instrument. So we'll have a preferred return that's, let's say, between 11% and 14%, depending on kind of the deal dynamics. And then...

Jon Stoddard (26:36.97)
That's a coupon that would start immediately if it's cash flowing or is there some kind of suspension?

Jason Ehrlich (26:41.394)
Yeah. Now, immediately upon closing, it starts accruing the preferred return. We strongly prefer businesses that have a cash flow profile that will pay that out current. We'll entertain a structure. Right. That's right. But we will entertain a structure where part of it is deferred. We don't ever want to have a fully just accrued prep that's not getting paid off at all. Once the prep is paid off and our principal is returned,

Jon Stoddard (26:53.406)
Yeah, that's where you get the 1.75. Yeah.

Jason Ehrlich (27:10.73)
At that point, those preferred shares typically convert to common. There's usually a step up basis where 1.5 to 2, let's say, that preferred return goes away. And we just participate in the distributions and the upside on the business on a pro rata basis with the operator from that point.

Jon Stoddard (27:29.758)
Yeah. Are you looking for individuals that have a bigger goal of, let's say, I'm going to do a roll up, or are you just looking for an individual that needs to buy, wants to buy a $5 million business and operate it for the next 10, 20 years?

Jason Ehrlich (27:45.71)
So we've done both. I'll say that roll ups introduce incremental risk. Acquisition is inherently time consuming, dangerous. Deals break integration risk. So if it is a roll up strategy, we usually like the terms to be a little more investor favorable to compensate us for the risk of going along with all of those subsequent acquisitions. My.

You know, perfect, you were describing the perfect scenario a few minutes ago for the deal that I'll do. The perfect scenario is the business is doing about $2 million in EBITDA. That's south of where private equity really wants to get involved, but $3 million is very interesting to small private equity. And so if you buy a business that's doing two and you operate it competently for five, six, seven years, you've probably grown it to a point where it's doing about three organically without a lot of the risk of bolt-ups and...

both ons and roll ups and all of that.

Jon Stoddard (28:42.794)
Yeah, I mean, for instance, you know, in the HBA industry, you're just, if I'm in Tucson, you're not going to grow past Tucson unless you're buying another business in Phoenix. Yeah.

Jason Ehrlich (28:53.762)
Sure. Yeah, that's right. We wanna make sure that there's a comfortable exit strategy. And if you're buying at 2 million, the exit strategy is you can do nothing, grow it organically and have a nice exit to private equity. If you're buying a business that's a million or south of a million, you're probably gonna have to do a lot of work if you want your exit multiple to be better than your entry multiple. But long story short, we'll definitely invest in both strategies and have.

Jon Stoddard (29:22.274)
So if the preferreds paid off and you convert your pref to common, are you looking for some kind of liquidation event for them or would you hold buy and hold forever?

Jason Ehrlich (29:36.834)
So we have a provision that we put in because we're operating out of a fund structure, we could have need for liquidity. So we put a provision in the operating agreement with our searchers that says, hey, if you haven't sold the business after five years, we have what amounts to a put option where we can basically force you to buy us out should we need to exercise that for liquidity. It's not our preferred exit. We would definitely rather hang with people for the long haul. And certainly we can't enforce anything before the five-year time horizon.

but we do kind of put that optionality in there in case we need it.

Jon Stoddard (30:09.45)
Yeah, so I know that this fund is fairly new and you probably haven't had that happen yet, right? Yeah, and if you have a portfolio of 10, 15, essential businesses with a minority shareholder, is this a portfolio that you could sell off to somebody or are you just talking about buying, holding, like Warren Buffett for the rest of your life?

Jason Ehrlich (30:15.916)
We have not.

Jason Ehrlich (30:33.838)
No, so the fund, the fund in and of itself, you know, we will raise and deploy capital in the first year, and then that the acquisition stops. And at that point, we're holding, and we're just providing support to our operators. We're not trying to turn around and sell our interests. In many cases, I think the operating agreements may prohibit us from doing something like that. So our ambition is just to be on the cap table, be there, support the entrepreneurs through their hold.

many of them will choose to exit one way or another inside of that, let's say, seven-year horizon. And those that don't, if we need to get bought off the cap table at that point, you like to hope and assume the business will be doing sufficiently well where that's not hard to do. And at that point, the entrepreneur can own the business outright.

Jon Stoddard (31:19.41)
Yeah. Do you get a board seat with this equity? Yeah. And what kind of strategic guidance do you are you sharing with the individual?

Jason Ehrlich (31:23.474)
Almost always, yeah almost always we do.

Jason Ehrlich (31:31.058)
Oh gosh, so that's a broad topic. We have a number of different sort of components of expertise on our general partner team. So for myself, I did a number of years in management consulting, and obviously we see a lot of small business. So I can personally advise on sort of a whole range of different business topics, whether it's trying to grow the top line or improve operations or whatever. We have folks on our board that are EOS, which is the Entrepreneurial Operating System, if your audience is familiar with that.

We have a member who's very expert in those implementations, so we can provide guidance on that. Another of our GP team is actually an operator, a searcher now turned operator himself, so he can provide all manner of anecdotes. It really kind of runs the gambit. We're not providing paid advisory services for the operators. We're there, invested in the deal. We're members of the board. We're sort of providing guidance as they

request it. And some businesses, the searchers, the entrepreneurs, very autonomous and is happy to sort of give us visibility into what's going on, but doesn't ask for our opinion a lot. And as long as things are going well, we're fine with that. Others are very happy to have our expertise and will ask us questions and will ask us to put together recommendations for things. And again, we're more than willing to do that too.

Jon Stoddard (32:52.19)
Yeah. Is that a kind of a partner on call kind of deal, or is that a, every three months, a board meeting required?

Jason Ehrlich (33:00.07)
Well, yeah, we like to see a cadence of the board meetings where there's updates, there's a little report on what's going on in the business, but then we're also available on call should there be some business challenge they want to talk through or opportunity they want to talk through.

Jon Stoddard (33:10.386)
Yeah. All right. So let's go to the investors that are putting money into this fund. They're high net worth individuals. And you did a, what kind of raise was this? A 506 REG D? Yeah. 506 C. Okay. So these high net worth individuals, they always have alternative investment opportunities, and they're going to look for the highest return, lowest risk.

Jason Ehrlich (33:22.326)
506C, yeah.

Jon Stoddard (33:37.29)
What does that look like when you present to them and say, hey, would you like to join the fund? We're buying Main Street businesses. Here's what the return looks like.

Jason Ehrlich (33:45.45)
Yeah, that's not our pitch, right? We're not saying, hey, it's the highest return with the lowest risk. We think there is a very attractive risk return profile here. When you look at the stats around failure rates, let's say, for these acquisition businesses, you look at the SBA loan failure rates are lower than 4%. You look at some of the research out there that says, of the segment that we're in, more than 90% of the business is acquired. They either maintain the EBITDA at the level it's at.

or they increase it. So 10% or fewer are actually even having a decrease in EBITDA, much less going under. So we think that sort of that risk adjusted return is definitely there, but I think it goes beyond that. This is providing key liquidity into Main Street, like we talked about. We're investing in small businesses, we're keeping jobs in communities. So I think there's definitely an impact element here that a lot of our investors...

We get through all of the financials and the risk metrics and all of that. They feel good about that. But then there's also this incremental layer of sort of doing well by doing good, if you'll pardon the cliche. But we do think that with our approach of putting, let's say, eight different deals in a fund and diversifying it across geographies and across sectors, it takes that already kind of good failure rate and it blends it even further to make that risk-adjusted return look better.

Jon Stoddard (34:52.338)
Nah, sonically, yeah.

Jon Stoddard (35:10.37)
So you have to have for the, well, I always like to say this right, for this fund to have kind of the returns that an investor is looking for, both with the heart and the head, you gotta have about eight of these types of companies in the fund.

Jason Ehrlich (35:28.278)
Well, I wouldn't say that, right? So we only deploy, we call in and deploy our capital once we have an opportunity ready. So I could have commitments all the way up to my 5 million, but I'm not going to ask each individual investor to wire in their funds until we're ready to put that money to work. And so let's just say hypothetically, and we're already past this, so it wouldn't happen, but let's say we only raised half of the capital. We'd only do four deals and...

the returns would be the same because we're sort of matching capital coming into deal. So we'd never get into a scenario where our deal funnel doesn't keep up with our capital raise.

Jon Stoddard (36:05.194)
Yeah. Let me ask you about these investors again. Now they're, they're clearly investing in Main Street businesses, right? Essential, uh, Main Street businesses. Do, do they, are they, sometimes you get these requests from them and like, Hey, I'm looking for the Uber type returns, the 30% plus and really high multiple on invested capital.

Jason Ehrlich (36:28.438)
Well, I mean, I know those investors are out there. We don't have a lot of those conversations, because our materials and our thesis is pretty clear. We're not looking for the unicorns or the rocket ships or whatever you want to talk about. This is not the high-risk, make or break kind of model. This is a lot closer to, if I think about commercial real estate as an asset class for my own parallels, this is the multifamily building that's diversified.

It's got stable revenue and it kind of chugs along and does what you think it's going to do over time. It's the business version of that, which certainly has more risk than real estate like we talked about, but significantly more upside. So, the investors that are trying to do startup investing or seed round venture or some of these more, I know 90% of them will fail, but the 10% that go are going to do 100X, and so it's worthwhile. That's a great investment thesis and plenty of people have gotten rich doing it.

It's not our approach and I think those people kind of get that right off that so people that come to us They're looking for more stability. They want growth. They want returns, but they also like preservation of capital They like to have kind of some of the tax efficiency that comes with direct ownership and they like to have cash flow

Jon Stoddard (37:45.118)
Yeah. What does that IR look like for somebody like this? Is it in the 2030 range or?

Jason Ehrlich (37:50.238)
Yeah, it's in the mid-20s is what we're projecting at the fund level. I'll say that since your audience is investors and searchers, when we are underwriting a deal at the search level, at the deal level, we're underwriting it more to the mid-30s. We want to be able to put in conservative assumptions around what revenue growth is going to look like, what operating margins are going to look like, what the exit multiple is going to look like. But then I turn around and I shave that down further.

when I talk to my LPs, we are a fund that always likes to over promise or under promise and over deliver to say that the right way. So yes, we're talking about mid 20s, we're underwriting to mid 30s and hoping to beat on projections.

Jon Stoddard (38:36.694)
Let me ask you about the word conservative. I remember a long time ago, somebody, an investor told me to stop using the word conservative because it means different things to different people. But if you're buying an HVAC company and it's perfect, 1.75 debt service coverage ratio, it looks beautiful, but they're historically only grown 5% a year, year in, year out. Like how are you getting a 25, 30, maybe tap on,

Jason Ehrlich (38:45.966)
Sure.

Jason Ehrlich (38:59.298)
Mm-hmm. Yeah.

Jon Stoddard (39:05.71)
IRR for an investor for something that's only grown at 5%.

Jason Ehrlich (39:09.074)
It has to do with the economics, right? If your purchase multiple is attractive enough and your operating margins are good, even if you just do continue growing at that same kind of rate, as long as the investors are getting the right proportion of the deal relative to their capital, you can absolutely achieve that kind of exit. I think that's the magic of this space. That's the magic of buying on a very low multiple. And I think, again, the scenario that we look for is one where.

Ideally, you're not trying to exit at the exact same multiple that you bought at in five to seven years. Ideally, you've grown, you're going to try to do a little bit better on that exit. We're not counting on a lot of that, but I think that can happen in a majority of these cases. So really, it doesn't take a ton, especially because these deals are leveraged with pretty good debt. It doesn't take a ton to make the returns pretty attractive.

Jon Stoddard (40:01.502)
Yeah, the debt would magnify the returns. But let's say, you know, you got these levers, right? You're looking for this return on the backend here. Have you ever gone back to the operator and the deal and say, hey man, your multiple is a little bit higher or we have to bring in more equity or more debt?

Jason Ehrlich (40:17.91)
Yeah, I mean, we absolutely provide feedback on the underwriting, and we're not asking them to necessarily change their own underwriting, but we might say, hey, you're offering a step up that's 1.4. And with our assumptions and what we're willing to give you as far as exit multiple expansion, as far as revenue growth, you're going to have to give us a 1.7 for this to make economic sense for us. And they don't have to change anything in their deal terms.

they may just have to give us a little bit bigger piece of the pie. And again, I say a little bit because in no case do we ever take more than 19% of a business. You know, that's an SBA threshold for getting into a personal guarantee territory, which the fund won't do. So we're always going to remain minority partners, but you may have to adjust the terms a little bit if, you know, the deal economics aren't stellar, let's say.

Jon Stoddard (41:09.962)
Yeah, let's talk a little sidebar on that, the step up, because a lot of people didn't come from private equity or venture capital. To understand what that step up means to the searcher, and definitely we know what it means to the buyer or the investor because they're gonna make, it's a sweetener, it's more dollar. But tell us a little bit about that.

Jason Ehrlich (41:30.154)
Yeah. Well, that's exactly what it is. It's designed to say, hey, investor, thank you for taking a chance on me here. And basically, we're going to put you further into the money at the moment that your shares convert from preferred to common. So if the business were to sell a day after that conversion, that the investors would make money. Again, like I mentioned, the common sort of terms that we're seeing are between...

1.5 and 2 times step up. And given, I think given.

Jon Stoddard (42:01.61)
Yeah, so that's a, so if an investor puts a dollar in at a participating preferred, it converts to 1.5, $1.50 at some kind of liquidation event. Okay, cool.

Jason Ehrlich (42:14.104)
That's right.

Jon Stoddard (42:17.79)
Yeah, 42 18. Those are my questions. Do you have any questions in here? I'll go back and that you want me to cover on this. This is fantastic conversation.

Jason Ehrlich (42:26.834)
No, it's been a good conversation. I think we pretty well covered it.

Jon Stoddard (42:29.694)
Yeah. Jason, thank you so much for being on the show. How can they get in touch with you if they're a great operator and they have a great deal?

Jason Ehrlich (42:39.242)
Yeah, absolutely. So, the easiest way to reach me is just via email, jason at fruitioncap.com. That's jason at fruitioncap.com. Obviously, our website is fruitioncap.com. We've got our deal criteria and things that we've talked about on the podcast are listed out there today. If you're an investor and our fund sounds interesting, fruition.com slash investors has a whole bunch of details sort of on the investor-facing side of the fund and you can reach me via email as well.

Jon Stoddard (43:09.578)
Perfect, thanks for being on the show, Jason. Hold on one second. So I'm gonna stop it and then it's gonna upload.

Jason Ehrlich (43:12.002)
Thanks, John. Great to be here.