A search fund serves as an investment vehicle, allowing investors to support entrepreneurs in the sourcing, purchasing, operation, and expansion of privately held companies.
This entrepreneurial approach, known as Entrepreneurship Through Acquisition (ETA), entails acquiring and expanding established small or medium enterprises (SMEs) with proven product-market fit. Individuals seeking businesses to acquire, referred to as searchers, also act as the principals of the fund.
Explore the Search Fund Journey Embarking on a search fund journey involves forming an investment vehicle with aligned investors. Positioned as an alternative investment category, these funds offer a lower-risk path for both entrepreneurs and investors, leveraging the success and recurring revenue of established enterprises. This creates a unique opportunity for new MBA graduates to step into the CEO role of a thriving enterprise, allowing them to "accelerate the car rather than build it."
Historical Development Originating at Harvard Business School in 1984 and further refined at the Stanford Graduate School of Business, the search fund model has gained global popularity. Professor H. Irving Grousbeck, credited with its development, has paved the way for aspiring entrepreneurs.
Early Success Story: Nova Capital One of the pioneers in this domain is Nova Capital, founded by Jim Southern in 1984. Southern's successful acquisition and growth of Uniform Printing, generating a remarkable return of over 24x a decade later, showcase the potential of this model.
Navigating the Fund Lifecycle The fund's lifecycle unfolds across four stages:
Fundraising
Search and acquisition
Operation and value creation
Exit
Fundraising involves a two to six-month process where principals raise funds from potential investors, categorizing capital into search and acquisition funds. Search capital covers expenses like office rent and travel, facilitating the search process.
Generating Deal Flow The search and acquisition stage, lasting twelve to twenty-four months, explores brokered and proprietary deals. Brokered deals involve businesses actively marketed through brokers, while proprietary deals, though more tedious, offer cost-effective opportunities through targeted outreach.
Insights into the Ideal Target Ideal acquisition targets exhibit characteristics related to industry, company, and finances. Key considerations include industry fragmentation, low cyclicality, consistent profitability, and financial metrics such as revenue between $5m and $50m.
Fund Economics and Value Creation Economic returns are driven by the structure of manager equity, investor capital, and value creation. Manager equity vests based on acquisition milestones, while investor capital is infused in search and acquisition stages.
Value creation hinges on operational improvements, financial engineering, and valuation multiples. Operational enhancements include organic and inorganic growth, while financial engineering addresses capital structure and cost considerations.
Examining Fund Returns According to the Stanford 2022 search fund study, these funds boast a historical average internal rate of return (IRR) of 32.6% and a 5.5x multiple on invested capital. However, a third of searchers faced challenges in identifying and acquiring businesses despite dedicated efforts.
Diverse Investment Landscape Numerous small investment companies specialize in supporting such funds, with examples including Anacapa Partners, Aspect Investors, and Search Fund Partners. Alternative models, like sponsored search, incubated search, self-funded search, and crowdfunded search, offer varied approaches to entrepreneurship through acquisition.
In summary, a search fund serves as a strategic investment vehicle, aligning investors and entrepreneurs in a journey of acquiring and growing established businesses, minimizing risks and maximizing opportunities for success.
