8 reasons (not) to launch a search fund
When I meet with prospective searchers, a few have already decided to launch a search fund, and I help them gain momentum. But most are in the exploratory phase and, though they may not phrase it this way, they really want me to help them answer the question, “Should I really do this?”
I’ll use this post to provide part of an answer to that question.
When deciding whether to launch a search fund, there are really two questions you need to answer:
Why should I (not) buy a business?
Why should I (not) use the search fund model to buy a business?
Many entrepreneurs I speak to are first introduced to the idea of buying a business in the context of the search fund model. However, a search fund is really just one form of what has come to be known as Entrepreneurship Through Acquisition, or ETA. People have been buying businesses for a long time. By contrast, relatively few have launched search funds. For this reason, I recommend bifurcating your decision making process.
Why should I buy a business?
Drawing on my own experience as a searcher and on the many conversations I’ve had with prospective and active search fund entrepreneurs, I’ll identify a few buckets into which their motivations typically fall:
1) I want to make a lot of money.
This goal is not unique to search fund entrepreneurs. Many startup founders, whether they admit to it, are motivated by the pot of gold at the end of the rainbow. Headlines are littered daily with large investment rounds and exits, creating new millionaires and billionaires each day, and they dream of becoming one of them. Likewise, aspiring search fund entrepreneurs hear of success stories and dream of being equally successful.
I can’t fault entrepreneurs for dreaming of riches. There’s little wrong with having quantifiable financial goals
However, if your only motivation for buying a business is financial, I would advise there are less risky paths that are also likely more aligned to your lifestyle preferences. Remember that this is a long-term project. After searching for a couple of years, you’ll operate for 5-10 years, taking up a good portion of the prime of your career. There are many ways to use 10+ years of your life to build wealth for yourself. Be sure to fully evaluate other potential paths.
That said, making a large chunk of change is certainly possible in the search fund model. The 2018 Stanford Search Fund Study cited 20 exited searchers and 32 operating searchers with at least US$2 million in equity value. One common rule of thumb in the search fund world is that if the entrepreneur is not projected to exit with at least $5 million at the end of the project in the base case scenario, it’s not a great opportunity. In fact however, a relatively small percentage of searchers achieve such an exit.
2) I want to be in private equity.
In top-tier business schools, private equity has a seductive allure of mystery and exclusivity. Very few can actually get hired into PE straight out of school, and it’s seen as an exciting path to success. Some aspiring searchers see buying a business as a backdoor into the private equity industry. They like the idea of using the search fund model to run a mini private equity firm, and perhaps even manage a small portfolio of investments.
While starting a lower middle market buyout fund is certainly a viable investment strategy, it’s not what the search fund model is designed for. Rather, it’s designed for an entrepreneur to execute one acquisition with the end goal of operating one business for a relatively long time. Inexperienced in, and in many cases uninterested in, the mechanics of M&A transactions, the search fund entrepreneur surrounds himself or herself with experienced deal professionals to help push that one deal over the finish line. The entrepreneur then moves on to the true aim of the whole project - running a business.
This approach is one of the fundamental differentiators of the search fund model and one of the greatest contributors to the model’s success thus far. If you aim to abandon this buy-and-operate model, and you would rather be a serial M&A professional, you should do that! But whatever you do will not be a search fund.
The search fund model, and ETA in general, is designed for an aspiring SME CEO, not an aspiring private equity professional.
3) I want to be my own boss.
Buying a business is absolutely a great way to be at the top of the company’s food chain. From day one as CEO you are empowered to allocate resources, make hiring and firing decisions, and drive the strategy of the company. You’ll be free to make your own schedule, your own meetings, and your own path.
However, it’s important to remember that as long as you’re taking someone else’s money to do this, you will never be 100% your own boss. You are required to update them regularly on your actions and progress, and if your controlling shareholders want something done, it’s often your responsibility to execute on those wishes.
Even if you don’t take others’ money, financing the entire acquisition yourself, some say you’re still not your own boss. The customers are your boss! This is especially true if your business suffers from customer concentration - those customers have have significant influence on your decision making.
As a CEO of a small business, you will be largely your own boss, especially day-to-day, but you’ll likely never reach 100% independence.
4) I want practice running a business before starting my own.
If your ultimate goal is to start a business, go start your own business. Buying and running an established SME is a very long-term project, and you’re likely going to get frustrated if all you really want to do is start your own business. Also, the experience you gain will be quite different from the experience of starting a company, especially if you’re planning to start a tech company that seeks VC funding.
5) I want the prestige and recognition.
While very few entrepreneurs are open about the desire for prestige and recognition, even with themselves, I think it is a fairly common objective. Self-validation is nothing to sneeze at.
However, you guessed it, there are a few caveats here. I recently heard someone say, “Entrepreneurship is a journey, and you never arrive.” In that same vein, even with the title CEO next to your name, you may always be looking up to people who are running bigger companies, or who are making more money than you, or who have been CEO of more companies or for longer than you. It’s endless. If you suffer from title envy, I would caution you against thinking buying a business will cure you of that ailment.
If prestige is what you’re looking for, you may find it hard to come by when running South Essex Pipe Cleaners. Placing that business card next to your McKinsey friend’s card will not be a fair competition. That said, there is endless opportunity to take pride in your own accomplishments while running the business you buy. Taking strides in a business you own and achieving goals set for yourself and your loved ones can feel amazing. But those accomplishments just might not be recognized by a broad audience and elevate you to high society. A more traditional job at a prestigious firm probably has a better chance of getting you there.
6) I’m dying to run a business.
Others want nothing more than the challenge and intellectual stimulus that come from running a business of one’s own. They want to be in that position of making company-level decisions as quickly as possible, but they don’t want to take on the risk of starting a company.
Bingo. This is a great reason to buy a business.
Why should I (not) use the search fund model to buy a business?
1) I want to reduce my risk as far as possible.
By design, the search fund model pairs the entrepreneur, who has likely never bought or run a business before, with a team of seasoned professionals who have bought and run many businesses. With this team behind you and economically incentivized to help you, you should be significantly less likely to screw up.
What’s more, during the search phase you will receive a paycheck, enabling you to reduce the financial risk and opportunity cost of buying a business. In either a self-funded search or a startup, you likely won’t see any income for quite some time.
When following the search fund model, you will also be taking a trodden path with proven, documented success. Many best practices have already been established, and you can learn from others in the search fund ecosystem who came before you.
2) I want my capital lined up early.
Having financial backing from the beginning produces several benefits.
Your investors’ interests will be more aligned with yours during the search, and they’re more likely to help you.
Your investors and you will establish a relationship throughout the search before going into a deal together.
You’ll enhance your credibility with sellers and intermediaries.
Raising capital for the acquisition will be faster and easier.
Action Items
Do some soul searching to get to your true motivations.
Jot down on paper your top 3-5 reasons for buying a company, and for launching a search fund.
Tell your loved ones who know you very well that you want to buy a business. Ask them to tell you what they believe your motivations to be. Then just listen! You may not hear what you want to hear, but don’t talk back. Just listen.
Research all other paths to entrepreneurship, to buying a business, and to whatever you’re trying to achieve - prestige, financial success, whatever. The search fund is just one avenue to achieve certain goals. It may not be the right avenue, and it may not help you achieve your true goals.
When you embark on this journey, you want to feel as confident as possible in your decision to do so. Doing some of this honest self analysis will help you get there.
