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Search Funds

Using

https://www.gsb.stanford.edu/sites/gsb/files/files-fpp/26891/ces-search-fund-study-2016.pdf

Search fund videos on Youtube

http://www.searchfund.org/#resources

https://www.gsb.stanford.edu/faculty-research/centers-initiatives/ces/research/search-funds

https://www.gsb.stanford.edu/sites/gsb/files/ces-search-funds-best-practices-search-phase.pdf

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Approximately $4.8 trillion of net worth, representing the largest inter-generational shift of wealth in U.S. history, will be transferred over the next 20 years as virtually all closely-held and family-owned businesses will lose their primary owner to death or retirement. How will these business owners "exit" these companies and get an acceptable buy-out that will let them retire on their hard-earned wealth?

A “search fund” is one possible solution

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A search fund is a pool of capital raised to support the efforts of an entrepreneur, or a pair of entrepreneurs, in locating and acquiring a privately held company for the purpose of operating and

growing it.

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Source: Stanford GSB

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What makes search funds unique?

Search funds are a type of investment vehicle that enables entrepreneurs to purchase and operate an existing small to medium-sized business. The main goal of search funds is to find and acquire a profitable company that has growth potential. Search fund entrepreneurs typically raise capital from investors to fund the search process, and then acquire a business using a combination of debt and equity financing.

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Some advantages of search funds

  • Potential for high returns
  • Reduced risk compared to starting a business from scratch
  • Access to experienced mentors and advisors

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Some advantages of search funds

One of the primary advantages of search funds is the potential for high returns. By acquiring a company with strong growth potential, search fund entrepreneurs can generate significant profits for themselves and their investors. In addition, search funds carry less risk compared to starting a business from scratch, as the acquired business already has a proven track record and established customer base. Finally, search fund entrepreneurs benefit from access to experienced mentors and advisors, who can provide guidance and support throughout the acquisition and operation process

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Challenges associated with search funds

  • Finding the right business to acquire
  • Negotiating a fair price for the business
  • Managing the acquired business effectively

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Challenges associated with search funds

Despite their advantages, search funds also face a number of challenges.

  • One of the main challenges is finding the right business to acquire. Search fund entrepreneurs need to be diligent in their search process, and evaluate a large number of potential businesses before settling on one to acquire.
  • In addition, negotiating a fair price for the business can be difficult, as sellers may have unrealistic expectations of their business's value.
  • Finally, once the business has been acquired, search fund entrepreneurs need to manage it effectively in order to realize its growth potential

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Stats from searchfund.org

  • Search funds typically target companies in the $5-30m price range, $1-5m EBITDA range, $2-30m revenue range, requiring $2-10m of equity capital, in (1) fragmented industries, with (2) sustainable market positions, (3) historically stable cash flows, and (4) long-term opportunities for growth and improvement.
  • Service and light manufacturing companies outside high tech industries are popular targets.
  • Often these companies are under-managed prior to the acquisition.

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Source: searchfund.org

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Stats from searchfund.org

  • Many are started by entrepreneurs with limited operational experience and possibly no direct experience in the target industry
  • The goal of the investor is to place promising, motivated managers in an environment with a high probability for success given the oversight and experience of the investors themselves.

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Source: searchfund.org

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Stats from searchfund.org

  • A 2016 Stanford Center for Entrepreneurial Studies analysis of 258 qualifying search funds found the aggregate pre-tax internal rate of return to be 36.7%, and the aggregate pre-tax return on invested capital to be 8.4x.

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Source: Stanford.edu

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Where are the search fund firms?

https://www.searchfunder.com/

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Lifecycle of Fund

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Lifecycle of a search fund: four stages

  1. Fundraising: get the money
  2. Search and acquisition: find the right investment
  3. Operation: run it until it’s a gem
  4. Exit: sell it

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Source: Stanford GSB

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1.Fundraising

  • The initial search capital is raised to finance the search stage—the identification, evaluation, and negotiation of an acquisition.
  • To raise initial search capital, principals often need to tap a wide network of potential investors, including friends and family, business associates, business school faculty, angel investors, business owners and executives, and institutional search fund investors

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Source: Stanford GSB

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2. Search and acquisition

  • Generating deal flow, screening potential candidates, assessing seller interest, evaluating and performing due diligence on the target company, negotiating the terms of the acquisition, raising debt and equity capital, and closing the deal.
  • When a target is identified, contributors of search capital are given the right of first refusal on their pro-rata share of new acquisition capital. Initial search capital is commonly stepped up by a certain percentage (e.g., 50 percent) in the acquisition round, whether or not the search capital investors decide to participate.
  • In addition to follow-on investment, acquisition capital can come from a combination of other sources: seller’s debt, bank loans, and equity financing from new investors.
  • Investor debt, commonly in the form of subordinated debt, may also be part of the capital structure.

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Source: Stanford GSB

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3. Operation

  • While completing the acquisition, principals (*you* the entrepreneurs) will recruit a board of directors for the company, which often includes substantial representation from the initial search fund investors.
  • In the first 6 to 18 months after the acquisition, principals typically make few radical changes, opting instead to learn the business and gain management experience.
  • After becoming adept at operating the business, principals then begin to make changes to improve and further grow the business.

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Source: Stanford GSB

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4. Exit

  • Most search funds are established with a long-term outlook, often no less than five to seven years
  • A typical search fund entrepreneur may spend on average six years from the beginning of the search to an exit
  • Liquidity events for investors and principals can occur in a number of ways, similar to exit opportunities for equity holders in a privately held company

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Source: Stanford GSB

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Search fund stages

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Source: Toptal.com

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Source: Toptal.com

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Source: Toptal.com

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Source: Toptal.com

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% of >10X return = .73 X .54 X .07 = 2.8%

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Source: Toptal.com

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Resources on Launching a Fund

Launching a Fund:

See also: The Search Fund Model: How to Become a 28-Year-Old CEO (Forbes.com, 2014). Favorite quote so far from the article: “after working at a start-up Chris realized the $0-1 million revenue range was very challenging and he would rather ‘accelerate the car than build the car.’”

Read the Forbes.com article linked above - if you can’t access the Forbes site then read this print version of the article.

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Coley Andrews: What it Takes to be a Search Fund Entrepreneur (7:10) Transcript

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“The search fund model is predicated on taking somebody with high potential, and surrounding them with people that can help them succeed.”

Additional resources: Pacific Lake Partners search fund conference videos

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Source: searchfund.org

Models of Entrepreneurship through Acquisition (EtA)

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“Self-funded searches” - an informal model of EtA

  • Entrepreneurs take on the costs and risk of searching for a company to buy.
  • Entrepreneurs keep a larger part of the ownership upon finding a company to acquire (Often retaining 50-100% of the ownership of the company). These entrepreneurs forgo the need for a large pool of investor/mentors and rely on personal experience, capability and informal mentorship in their search, closing and operating decisions. This approach is much less standardized and the investor base is less conforming than "classic" search fund investors.
  • Entrepreneurs generally buy smaller companies ($500k to $2.5m EBITDA) and finance their acquisition with personal equity (0-30%), investor equity (10-35%), seller note (10-35%) and senior bank debt (30-60%).

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Source: searchfund.org

Side note: If you forgo a salary of $100,000 in a big corporation to be CEO of an EtA company for $40,000/year for three years, few will expect you to invest

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WIIFM?

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After getting stung by the financial crisis of 2008, search funds resurged in 2013 to record highs in 2015

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Private Equity Info search for search funds in U.S.

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Bonus presentation: Coley Andrews of Pacific Lake, “Speaking from Experience” (18:32)

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Discussion: Buying a business with a search fund (GSB, 30:46, for a more detailed discussion of process, potential, pitfalls)

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