Isn't a search fund just mini private equity?

The private equity industry has gotten a bad rap over the years, earning a reputation for ruthlessly gutting companies and selling them for scraps. Mitt Romney can attribute part of his failed 2012 presidential campaign to his prior association with the private equity firm Bain Capital, and the fabled stories of its aggressive LBOs.

But technically, private equity investors are simply in the business of investing in private companies. Venture capital is a form of private equity, because it also makes investments in private companies. Most startups you’ve heard of have technically taken money from private equity investors. Private equity investments need not be of the variety often criticized in the mass media.

Search funds are technically also a form of private equity, because they are in the business of acquiring and operating private companies. But they shouldn’t be lumped in with the rest of the industry. In fact, search funds typically work pretty hard to differentiate themselves from the PE industry, primarily in the following ways:

1. Search funds start with the management solution. A search fund is launched by an entrepreneur whose sole aim is to search for, acquire, and operate a business. The one who identifies the business in the first place is the one who will step in to operate that business. There is no need to find a CEO post-acquisition.

2. Search funds have no portfolio objective. The goal of a search fund entrepreneur is to acquire a business that she can operate for the long-term. Rather than seeking assets to complete a diversified portfolio, her sole focus is the success of that one business she acquires.

3. Search funds have no fixed investment horizon. Whereas a typical PE fund must return capital to investors within a fixed period, which typically necessitates an exit within that period, a search fund is not bound by such a horizon. Many search fund investors prefer to hold onto a good investment for a decade or more.

4. Search funds buy smaller companies. The size of search fund acquisition deals varies by market, but in general the objective is to buy companies that are too small to be on the radar of traditional private equity firms, and too big for most individuals to access on their own. By addressing this gap in the market, search fund entrepreneurs can be attractive buyers for businesses in that size range.

5. Search funds have an involved investor base. A search fund typically has 10-20 investors, usually HNWIs and family offices. They bring a diverse set of experiences, and many want to be closely involved in the acquired company, some participating as board members and adding value wherever possible. By contrast, the LPs of a traditional private equity firm are generally more passive and have little interest in getting involved with the portfolio companies.

6. Search funds are personal. The origin of a search fund is an entrepreneur who would like nothing more than to buy and run a business, and she has determined that a search fund is the vehicle most equipped to help her achieve that objective. She has dedicated the next decade or more of her life to this project, which is most often smack dab in the prime of her career. Her opportunity costs are huge, but so is the satisfaction she will feel when she is effectively managing a business she has acquired.

Action Items

1. In your next call with a broker, preferably one that has often dealt with PE firms, describe your approach and ask her to compare it to that of PE buyers they typically work with. This will help you familiarize yourself with the language and nuances in your market.

2. Commit these differences to memory so you can rattle them off the next time you’re asked, “So it’s like private equity?” Pay particular attention to #1-4.