In the world of entrepreneurship, there are numerous pathways to business ownership.
One path that has seen significant and ever growing attention in recent years is the search fund.
This guide aims to introduce entrepreneurs, MBA students, and investors to the fundamentals of search funds, setting the stage for a series of more specific guides that will follow and dive into all the different aspects of the search fund model.
What is a search fund? An Overview
At its core, a search fund is an investment vehicle designed to allow aspiring entrepreneurs and business owners to find, acquire, manage (and hopefully grow and potentially exit) a privately held company. The concept emerged in the 1980s at Stanford University and has since become a popular model for those looking to enter the world of entrepreneurship through acquisition (ETA). ETA is sometimes used as an alternative name for search funds.
If you want to hear the perspectives of Irv Grousbeck, the professor that shaped the search fund model, here is a great clip:
Key Components of a Search Fund
- Raising Capital:
- The process begins with an entrepreneur (referred to as the “searcher”) raising a small pool of capital from a group of investors. This initial funding, often referred to as “search capital,” is used to cover the searcher’s living expenses and costs associated with identifying and evaluating potential acquisition targets.
- Search Phase:
- With capital in hand, the searcher then enters the search phase, which typically lasts between 12 to 24 months. During this period, the searcher actively seeks out suitable businesses to acquire. Ideal targets are usually profitable, stable companies with annual revenues between $5 million and $50 million or EBITDA between $1m and $10m.
- Acquisition:
- Once a target company is identified, the searcher presents the opportunity to the initial investors, seeking additional capital to fund the acquisition. If the investors approve, they provide the necessary funds, and the searcher acquires the company. Given search funds acquire profitable businesses, there is typically a component of debt used to finance the acquisition along with the equity provided by search fund investors.
- Operation and Growth:
- Post-acquisition, the searcher transitions into the role of CEO, taking on the responsibility of managing and growing the acquired business. The ultimate goal is to enhance the company’s value, creating a profitable exit for the investors and the searcher.
What are the benefits of a Search Fund?
For Entrepreneurs
- Ownership Opportunity:
- Search funds offer a unique pathway for aspiring entrepreneurs to own and operate a business without having to start one from scratch. This can be particularly appealing for MBA graduates or individuals with a strong desire to lead a company but lacking the initial idea or capital to launch a start up from scratch.
- Mentorship and Support:
- Search fund investors often bring a wealth of experience and expertise to the table. They provide valuable mentorship and guidance to the searcher throughout the search and acquisition process but also future value creation, increasing the likelihood of success.
- Reduced Risk:
- By acquiring an established business with a proven track record, searchers can mitigate some of the risks associated with starting a new venture, especially when compared to VC backed start ups. This can lead to a more stable and predictable path to success.
For Investors
- Attractive Returns:
- Search funds have historically delivered attractive returns to investors. According to a 2022 study by Stanford Graduate School of Business, when looking at all search funds since 1986, they have delivered aggregate pre-tax returns of 35.3% internal rate of return (IRR) and 5.2x return on investment (ROI). This is a key driver of search funds increasing in popularity.
- Diversification:
- Investing in search funds allows investors to diversify their portfolios by gaining exposure to private companies across various industries. This can help spread risk and enhance overall portfolio performance.
- Active Involvement:
- Search fund investors often take an active role in the search process, providing strategic guidance and support to the searcher. This level of involvement can be both intellectually stimulating and rewarding.
If you’re interested in hearing the perspective of an investor and aithority in the search fund space, check out this interview with leading European search fund investor Moonbase Capital founder Ibrahim Abdel Rahim:
What are the different types of Search Funds?
Traditional Search Funds
Traditional search funds follow the classic model outlined above. The searcher raises capital from investors, conducts a search, acquires a company, and transitions into the CEO role. This model has been the most common and widely studied.
Self-Funded Search Funds
In a self-funded search fund, the searcher uses personal funds to finance the search phase. This approach allows the searcher to retain a larger equity stake in the acquired company, as they are not reliant on external investors for search capital. However, it also entails greater personal financial risk.
Accelerator Programs
Some institutions and investment firms offer structured accelerator programs for searchers. These programs provide mentorship, resources, and sometimes even capital to support searchers throughout the process. Examples include programs run by business schools or dedicated search fund accelerators.
Who are ideal candidates for a Search Fund?
Background and Experience
Ideal candidates for a search fund are typically individuals with strong leadership skills, a passion for entrepreneurship, and a background in business or finance. MBA graduates are often well-suited for this model, given their training in management and strategic thinking. Other searchers may be experienced operators/managers who want to take their experience and use it in a more entrepreneurial context. In some instances, search fund entrepreneurs might also be exited founders who have previously built and sold a business, and now want to replicate their approach in a new business that might be bigger than their last, with the search fund model giving them a chance to move faster than starting from scratch.
Personal Attributes
Successful searchers possess a combination of resilience, perseverance, and a willingness to take on significant responsibilities. The search phase can be challenging, requiring extensive networking, cold outreach, and due diligence. Individuals who thrive in dynamic and uncertain environments are likely to excel in the role of being a search fund entrepreneur. Entrepreneurship generally is not for everyone – whilst the rewards can be significant, so can the risks and the personal sacrifices that come with building something successful.
Check out our post here on what makes a successful search fund entrepreneur if you’re weighing up search funds as a path for you.
What are common search fund challenges and considerations?
Lengthy Search Process
The search phase can be time-consuming and demanding. Searchers must be prepared for the possibility of an extended search period, during which they may face uncertainty and rejection.
Financial Risk
While search funds offer a unique pathway to business ownership, they also carry financial risks. Searchers often invest personal funds in the search phase and may face financial pressures if the search takes longer than anticipated.
Operational Challenges
Transitioning from the search phase to the operational phase can be challenging. Searchers must quickly adapt to their new role as CEO and effectively manage the acquired business to drive growth and value creation.
Finally, if you’re looking for a search fund podcast to listen to, we love this episode from Think Like an Owner that takes a look at the 2024 Stanford Search Fund Study and runs through some of the key findings of the report. This is a must listen for anyone in and around the search fund ecosystem:
Concluding – what are search funds?
A search fund represents a compelling opportunity for aspiring or experienced entrepreneurs, MBA students, and investors to participate in entrepreneurship through acquisition. By understanding the fundamentals of search funds, you can better appreciate the potential benefits and challenges associated with this model.
Throughout the rest of this guide, we will explore specific aspects of search funds in greater detail, providing actionable insights and practical advice to help you succeed in your search fund journey – whether a search entrepreneur or investor.
Sources, citations and recommended reading:
- Accountancy firm Buzzacott does a great job of introducing the search fund model here: https://www.buzzacott.co.uk/insights/an-introduction-to-search-funds-entrepreneurship-through-acquisition
- The Corporate Finance Institute shares a good technical definition of what a search fund is here: https://corporatefinanceinstitute.com/resources/career/search-fund/
- We like to get the angle of lawyers, so here is a helpful explainer on search funds from law firm Sequoia Legal: https://sequoialegal.com/blog/what-is-a-search-fund-and-how-does-it-work
- Pacific Lake are one of the best known search fund investors, and share this post explaining what a search fund is on their website: https://www.pacificlake.com/intro-to-search-funds
