Search funds have emerged as an increasingly popular way for entrepreneurs to acquire and grow businesses. Whereas the traditional path to entrepreneurship often involves starting a company from scratch, search funds offer the opportunity to take over an existing business. But how do search fund entrepreneurs actually make money? How much equity do they receive in the company they acquire? This guide post will delve into the structure of a search fund deal, the typical equity held by the search funder, and the potential financial rewards.
Understanding the Search Fund Model
A search fund is essentially an investment vehicle created to finance an entrepreneur’s efforts to locate, acquire, and manage a privately held company. The process can be divided into several key phases:
- Fundraising: The entrepreneur raises a small amount of capital from investors to fund the 2-3 years it will take to search for a suitable company. This initial capital covers the entrepreneur’s living expenses, the cost of due diligence, and any other expenses related to the search.
- Search: The entrepreneur actively seeks out acquisition targets, often focusing on established businesses with stable cash flows and growth potential.
- Acquisition: Once a target company is identified, the entrepreneur raises additional capital to finance the acquisition. This typically comes from the same investors who funded the search or new investors.
- Operations: After acquiring the company, the entrepreneur takes on the role of CEO, working to grow and improve the business.
- Exit: Finally, the entrepreneur and investors may choose to exit the investment through a sale or other liquidity event, ideally resulting in significant returns for all parties involved.
Deal Structure and Equity
The structure of a search fund deal is designed to align the interests of the entrepreneur and the investors. Here’s a breakdown of how these deals are typically structured:
Initial Search Phase
During the initial search phase, entrepreneurs usually raise between $300,000 and $500,000. This capital is used to cover their salary and search-related expenses. Investors, often high-net-worth individuals or small private equity firms, contribute to this pool, receiving a combination of debt and equity for their investment.
Acquisition Phase
When a suitable company is identified, the entrepreneur raises the capital required for the acquisition. This can range from $5 million to $50 million or more, depending on the size and nature of the business. Investors provide most of the capital, but the entrepreneur often invests some money personally to demonstrate commitment and there is usually a debt component in the capital structure of most search fund acquisitions.
Equity Distribution
In return for funding the search and acquisition, investors receive a significant portion of the company’s equity. However, the entrepreneur also retains a substantial equity stake, usually ranging from 20% to 30% of the company post-acquisition. This equity can be split into different classes of shares to ensure both parties’ interests are protected.
How much equity does a search fund entrepreneur receive?
The answer to this question really depends on the deal, structure and type of search fund being undertaken (for example a traditional search vs a self funded search). However, in a traditional search fund model, a single searcher entrepreneur might expect to receive approximately 25% of the company they end up acquiring eventually.
As an example, this might be structured as:
- 8.33% upon successfully acquiring a company
- 8.33% that vests over a time period (e.g. 4-5 years)
- 8.33% in the form of carry in the fund
This structure is intended to align the incentives of both entrepreneur and investors, ensuring that the search entrepreneur can be well remunerated for successfully finding an acquisition, managing the business and eventually recognising the value of their work if the company sells again in the future once investors have first received a return on their investment.
Incentives for the Entrepreneur
To further align interests, search fund entrepreneurs often receive additional incentives based on the company’s performance. As described above, often in the traditional search fund model, this comes in the form of ‘carry’, meaning that once investor money has been returned, the entrepreneur themselves begins to share in the outcome of the value creation they have delivered when the company they acquired is exited. Other forms of incentive could include stock options, performance bonuses, or profit-sharing arrangements, designed to encourage rapid growth and value creation.
Potential Financial Rewards
The earning potential for search fund entrepreneurs is substantial, albeit with considerable risk involved. Here’s a look at how much money an entrepreneur could make at different stages of the process:
Initial Compensation
During the search phase, entrepreneurs typically receive a modest salary to cover living expenses. This ranges from $50,000 to $100,000 per year, depending on the cost of living in their area and the amount of capital raised. Stanford GSB’s 2020 Search Fund study identified the mean salary of a traditional searcher as $110,000 USD.
Equity Value
The primary financial upside comes from the entrepreneur’s equity stake when the company they sourced, acquired and ran for a number of years is exited again in the future. Suppose the entrepreneur holds 25% equity in a company acquired for $20 million. If the business grows and is later sold for $80 million (a 4x return), the entrepreneur’s equity could be worth a significant amount after considering any dilution from stock options, additional investment rounds and first returning capital to investors above the hurdle rate.
Performance Bonuses
Some search fund deals include performance-based incentives. Entrepreneurs who exceed performance targets may receive additional equity or cash bonuses. These arrangements can significantly boost the entrepreneur’s total earnings and are particularly common in high-growth businesses.
Recommended Watching
We loved this interview with Sandy Paige. He has a remarkable story, facing lots of challenges in his personal life that impacted the timing of his search fund journey, but he went on to achieve an incredible and sizeable outcome through his search fund.
Sources, citations and recommended reading:
- The equity breakdown above is explained in Jan Simon‘s great book on search funds / entrepreneurship through acquisition – we recommend you giving it a read if you haven’t already: https://www.amazon.co.uk/Search-Funds-Entrepreneurial-Acquisitions-Business/dp/0228861764
- A legal perspective is always helpful, so we enjoyed reviewing this blog post from law firm Inspire Law Group which also takes a look at compensation for search fund entrepreneurs: https://inspirelawgroup.com/news/what-compensation-and-equity-can-a-search-entrepreneur-expect/#:~:text=The%20amount%20and%20structure%20of,30%25%20from%20a%20successful%20investment.
- SMEVentures always produce great content, and this blog post is no different – check it out for more insights on how much money a searcher might make from a successful search fund outcome: https://www.smeventures.com/insights/how-much-money-can-a-search-fund-entrepreneur-make
Conclusion
Search funds offer a unique path to entrepreneurship, providing the opportunity to acquire and grow an established business with the backing of experienced investors. While the process involves considerable risk and effort, the financial rewards can be substantial. Through a carefully structured deal, aligning the interests of both entrepreneurs and investors, search fund entrepreneurs can achieve significant equity ownership and unlock long-term wealth creation opportunities.
If you’re considering embarking on a search fund journey, it’s essential to thoroughly understand the structure, risks, and potential rewards. Be prepared to invest significant time and effort into finding the right acquisition target and be ready to leverage your skills to grow the business once acquired. With the right strategy and execution, search fund entrepreneurship can be a highly rewarding venture.
