Search Fund popularity is rising.
But what is a search fund? How does it work? And why is it becoming more common?
A search fund is an investment vehicle through which investors financially support an entrepreneur’s efforts to locate, acquire, manage, and grow a privately held company.
Basically a relatively inexperienced, yet confident entrepreneur believes in themselves and their ability to add value to a company by acquiring it and assuming management roles.
Search funds usually provide attractive financial returns and mentorship opportunities for both the managers and investors.
But how does this model differ from PE or VC?
The Search Fund Model:
Remember the fund-launch formula I teach?? Yeah, search funds basically have the opposite approach.
1. Raise Initial Capital
I told you it was opposite from the usual… You first START by finding investors.
These investors not only provide capital, but also often act as advisors on deals and could potentially become board members.
Investors are basically betting on a jocky…but the investment mentality is:
“higher risks = higher returns“
Through investors’ participation, they can add significant value to the fund and newly acquired business. Which is why search funds are the new and exiting form of Private Equity.
2. Identifying a Business
After capital, you work on identifying a business.
Acquisition targets are typically:
- a business that has a middle-aged founder looking to turn over the reins
- have an older founder trying to retire
- business ran by a warring pair of co-founders needing to bring in new management
- a company with high growth potential
- a strong middle management team
- stable industry structure
- straightforward business model
Unlike other funds, search funds only have ONE opportunity to find the PERFECT deal. And it’s no easy process.
Search funds usually have a time clock on their acquisition. They will tell investors that if they don’t identify a company with pursuing within the next 2 years (or whatever timeline is defined) then the deal is off.
The coming months for the fund managers will consist of cold calling, networking, and pitching to businesses until you find one that fits the fund’s investment thesis.
3. The Acquisition
The acquisition follows the PE acquisition steps.
This step involves the deeper analysis of the company; considering margins, sourcing debt financing, performing due diligence…the nitty gritty.
The acquisition capital package is put into place, the offer is made, and hopefully the company agrees!
4. Operation and Value creation
The main goal will be to first analyze and understand the business, create and adjust a value-growth plan, then work on executing the plan.
Investors and middle management alike coach the new CEO in specific company management, leading people, and creating value.
The nice part about this is you’re not doing it all alone…this is where your knowledgeable, experienced investors come in extremely handy!
5. Exit/ Continue in Management
There are only two means to this end.
After experiencing a steep learning-curve, these young CEOs either choose to sell the company and pay out investors, or continue in managing the company.
The average search fund operates under the new business anywhere from 3-10 years before exiting.
The aggregate IRR of 32.6%. That’s a hefty return for those willing to take the risk and do the work!!
“The search fund community continues to grow, thrive, and change. The last two years saw records in the number of search funds launched, acquisitions made, and successful exits.”
The search fund model will continue to evolve and improve as it becomes more of a staple asset class.
Don’t miss out if you think you’re a fit for this up- and coming- fund trend!
Contact me with any questions concerning starting a search fund or investing in one!
Thanks for the read!
DISCLAIMER: This content is for educational and informational purposes only. It is not to be taken as tax, financial, or legal advice. You should always consult a legal professional before taking action. Furthermore, this is not a recommendation to buy or sell any security. The content is solely just the opinion of the authors.