The case for the self-funded search

I recently published the risks of self-funding your search, which was intentionally one-side. Here's the other side of the story.

The "self-funded search" was all that existed before search funds came along, and it's clearly worked well for many. Even today, the search fund model hasn't touched most of the world, but believe it or not, people are still buying companies!

In general, people self-fund their search for three reasons:

1. Flexibility
2. Independence
3. Necessity

Flexibility

The search fund model is fairly prescriptive and hasn't changed a great deal since inception over 35 years ago, despite the fact that the pool of entrepreneurship through acquisition (ETA) entrepreneurs has diversified and globalised. Adopting the search fund model for one's ETA ambitions can therefore feel like trying to fit a square peg in a round hole at times.

The round hole

If one is launching a search fund, she is necessarily following a pre-ordained ETA recipe that comprises the following ingredients:

1. The searcher raises capital from investors to fund the search.
2. These investors benefit from a 50% step-up on their initial investment and right of first refusal on participation in the acquisition round.
3. The searcher is paid a salary while she executes a full-time search for an acquisition target that aligns with the investment criteria she presented to investors. These criteria typically describe an "enduringly profitable" business generating $1-5m EBITDA anywhere in the searcher's target country.
4. Post-acquisition the searcher assumes the role of CEO and operates the target company full-time until exit.
5. The searcher earns an equity interest, some of which vests upon acquisition, some over time, and some as the deal clears performance thresholds, typically measured by IRR.
6. The board typically comprises the searcher and 2-3 investors.

A different hole?

If your ideal path diverges from the above recipe, then you might consider self-funding your search, and in so doing you would be joining a long line of entrepreneurs who have bucked the search fund wave and chosen to self-fund their search.

Many self-funded searchers have chosen not to follow the search fund model for at least one of the following reasons:

Geographic flexibility

Search fund investors usually want the searcher to conduct a "nationwide" search, thereby theoretically maximizing the probability of finding an attractive target. Self-funding your search allows you to set the geographic boundaries of your search as you see fit.

Industry flexibility

Self-funding your search will allow you to commit to buying a dog grooming business, and nothing else, if you so choose. Whereas investors would typically see this as too narrow a scope for the search, and would therefore be reluctant to front the search capital, it's none of their business if you don't take their money!

Less capital to return

Even if you plan to fund the entire acquisition with third-party capital, there is good reason not to take more capital than you need. Less capital raised means less capital that needs to be returned before your shares have value.

Investor selection

If you raise search capital, those investors have assumed additional risk and are compensated for that risk with the step-up and optionality mentioned above. By contrast, self-funding your search gives you the flexibility to build your cap table from scratch once an acquisition target has been identified.

Also, you may really want an investor in your deal who doesn't have the appetite to fund the search. Self-funding your search removes that obstacle and allows you to include this investor in your deal.

Flexibility on terms

By self-funding your search, you're not locked into the typical search fund equity structure. This means (in theory) that if you find a very attractive target, you have the power to set the terms as you see fit.

Independence

Many people who pursue entrepreneurship name independence or autonomy as one of their drivers for doing so. And when you're buying and running a business, you certainly get that.

There is, however, a spectrum, and I need to call out the fact that as soon as you take someone else's money, you're no longer entirely independent. Whether this is search capital, acquisition capital, or customer payments, people give you money because they expect something from you, and you are therefore accountable to them.

If you raise search capital, you are accountable to the investors who contributed that search capital. If you don't, you may still set up some form of accountability system, but there's nothing legally obliging you to deliver until you do raise capital.

Many searchers see this formal accountability during the search phase as a good thing, but others would prefer to defer it until post-acquisition, even if their search criteria are well within the normal bounds of search fund investing. Or if they plan to fund the acquisition themselves as well and never take investor capital, they may remain lone wolves for much longer.

Necessity

Some searchers are just unable to raise search capital, or at least unwilling to devote the time required to do so. This often happens in markets new to search funds, where a great deal of investor education is required.

Despite this challenge, these searchers will let nothing stand in their way of buying a company. So they scrape together everything they can, and hang on until they can close on an acquisition… or run out of money.