What Is a Search Fund?
A search fund is a special type of business investment supporting entrepreneurship through acquisition. In a search fund, entrepreneurs, known as "searchers," raise money from investors to find and buy a promising privately-owned company. The search fund model is popular because it aligns the interests of investors and entrepreneurs. Search fund investors get to support entrepreneurial ventures and earn equity in the acquired business as part of their investment. In turn, searchers get the mentorship and search capital needed to acquire and ultimately run a successful business.
How Search Funds Work
Search funds operate as a unique investment vehicle offering a pathway for aspiring entrepreneurs, while reducing risks associated with starting a business from scratch. Candidates are typically individuals with a strong business background, such as recent MBA program graduates or aspiring entrepreneurs driven by a desire to lead and operate a company.
Building search fund acquisition capital from investors involves finding partners who believe in the abilities of the searchers. This process can take several months to a year, depending on the network and track record of the individuals involved.
Many funds target small to mid-sized family-owned or founder-led businesses, presenting opportunities for transitions in ownership and leadership. Once a target is identified, negotiations and due diligence commence. The due diligence process for a search fund involves thorough assessment of the target company's financials, operations, market position, and growth prospects. Searchers work closely with advisors and experts to ensure the acquisition is sound and aligned with their investment thesis.
The target companies for search funds are often business owners who are looking to retire or transition out of day-to-day operations. These sellers see search fund acquisitions as an opportunity to pass on their legacy, while ensuring the continued growth of the acquired company and success of their business under new leadership.
How Are Traditional Search Funds Different from Private Equity and Venture Capital?
Search funds, private equity (PE), and venture capital (VC) are investment strategies with different scopes and objectives.
- Search funds are centered around individual entrepreneurs or small teams seeking to acquire and operate a single established business.
- Private equity firms deploy capital across multiple investments, often acquiring controlling stakes in more mature businesses to drive operational improvements and growth over several years.
- Venture capital focuses on early-stage or startup companies with high growth potential.
Each investment model differ in their risk and return profiles.
- Search funds have potential for significant returns if the acquired business is successfully grown and eventually sold, with risk mitigated through thorough due diligence.
- Private equity targets businesses with predictable cash flows, aiming for steady returns through operational enhancements and strategic initiatives. Returns are often realized upon buyout through a sale or IPO.
- Venture capital investments are characterized by higher risk and potential for high returns, with success dependent on the rapid growth and market dominance of the startup.
Benefits of Search Funds
- Entrepreneurial opportunity. Search funds offer aspiring entrepreneurs the chance to lead and operate a company without starting from scratch, leveraging their skills, ambition, and education.
- Focused investment. Search funds concentrate on acquiring a single business, allowing for deep due diligence and operational involvement post-acquisition.
- Shared interest in incentives. Investors and searchers have aligned interests in successfully growing the acquired business. Both will benefit from its increased value.
- Potential for high returns. Successful search fund acquisitions can yield high valuation, which means significant returns for investors. The potential often outperforms traditional private equity investments.
Risks in Running a Search Fund
- Acquisition risk. Identifying a suitable target business within the designated search period can be challenging.
- Operational challenges. Growing a business can reveal unforeseen operational difficulties. An investor must be sure the searcher has effective leadership and management skills.
- Financial liabilities. Searchers are typically personally liable for part of the acquisition financing, which can be a significant financial commitment.
- Time and resource intensity. Running a search fund demand substantial time commitments. The due diligence and operational responsibilities can be exhausting.
- Market conditions. Economic downturns or industry-specific challenges can affect investor returns.
- Limited track record. Search funds may lack a proven track record compared to established private equity or venture capital firms. This can result in investor skepticism or difficulty in fundraising.
How to Buy a Business With a Search Fund
The process of acquiring a business through a search fund involves several key steps.
1. Assemble a Team for the Search Phase
- Engage a buy-side broker to assist with sourcing and negotiating potential deals.
- Retain legal counsel specializing in mergers and acquisitions for guidance through legal complexities and documentation.
- Hire an accountant to conduct financial due diligence and ensure accuracy of financial statements.
- Seek advisors or mentors with industry-specific knowledge to provide insights during target evaluation.
2. Buy a Business
- Define the potential target industry, company size, and geographic preferences.
- Secure funding using a combination of equity and debt financing.
- Conduct a thorough search for potential acquisition targets and evaluate financials, operations, and growth potential.
- Negotiate the deal with sellers, structuring terms and conditions of the acquisition agreement.
- Perform detailed due diligence to validate financials, legal standing, and operational aspects of the business.
- Close the deal to transfer ownership.
3. Determine Post-Acquisition Involvement of Investors
- Investors may provide strategic advice and industry connections to support growth initiatives.
- Many investors look to monitor the acquired business's performance and financial metrics to track returns on investment.
- Investors may assist with implementing operational improvements or expansion strategies to enhance the business's value.
- Collaborate with investors to plan and execute an exit strategy, potentially through a sale or recapitalization to realize returns on investment.
How Soon Do Search Fund Entrepreneurs Look to Exit and Sell Their Businesses?
Search fund entrepreneurs typically aim to exit and sell their businesses within four to seven years of acquisition, depending on market conditions and business performance. While they may hold onto the business for longer, the ultimate goal is to increase the business's value to produce a strong internal rate of return upon exit and move on to the next opportunity.
Serial entrepreneurship involves starting, growing, and exiting multiple businesses during a career. For search fund entrepreneurs, this may mean acquiring and growing multiple businesses. Repeated opportunities offer the chance to apply lessons learned, diversify investments, and build a track record of successful acquisitions and exits. It requires resilience, adaptability, and a high risk tolerance, especially during the first year. Each new venture presents unique challenges and opportunities. Explore businesses for sale on BizBuySell that match your search fund criteria.