Want to buy a business? Try a search fund.

Search fund, you say?

If you've never heard of a search fund before, you're in good company. It's a very niche asset class that has been very lucrative for a very small number of people. Though it is indeed a form of private equity that has been around since the 1980s, even most PE professionals will struggle to tell you what a search fund really is.

And yet, I've chosen to focus this blog on search funds. Why? I think more people should know about them, especially outside of the US, where the model was born and raised, and where it is now beginning to flourish. I know of many entrepreneurs, investors, and business owners who could benefit greatly from this model… if only they knew about it.

I also happen to know quite a bit about search funds, having launched one myself and mentored many search fund entrepreneurs (a.k.a. searchers), both during my time at Search Fund Accelerator and since. I've learned a great deal along the way, and I thought I'd share.

So what is a search fund, really?

A search fund, at its core, is a niche private equity vehicle that joins a bright-eyed and bushy-tailed entrepreneur with a team of seasoned (and wealthy) investors, all with the sole aim of buying and operating one SME, and of course creating value along the way. To frame it a different way, a search fund is also one form of what has come to be known as Entrepreneurship Through Acquisition (ETA), or the individual endeavor of searching for, buying, and operating an existing business rather than starting one from scratch.

The model has been wildly successful - the Stanford 2018 Search Fund Primer claims a historical IRR of 33.7% and 6.9x multiple of investment (28.3% and 3.0x if you exclude the 5 most successful searches).

And yet nobody has heard of a search fund. Why not?

For starters, the model was born into an elite community of top-tier MBA students and professors at Harvard and Stanford, and for the most part it has remained within that circle. The few serial search fund investors are satisfied with their deal flow from a handful of top American business schools, and the schools themselves have had little incentive to spread the good word beyond their walls.

Another reason for the model's lack of publicity is that it deals in small companies. In a world of multi-billion-dollar M&A headlines, few notice Joe's Auto Service being sold for a few million. That includes large PE firms, who would rather spend their time on the larger deals.

It's also just really, really hard. Not everyone can power through years of searching for one business to buy, and then manage that business for years more, knowing the whole while that there's a real possibility that they'll come out the other end with nothing to show for their efforts. Even among top-tier business school students, who have never been accused of being overly modest, most shy away from the model in favor of something less risky.

The Six Phases of a Search Fund

But here you are, and now you know there is such a thing called a search fund. If you choose the search fund path, your journey as a searcher will go something like this:

1. You raise search capital. This is the funding you'll need to pay your salary during the search (Yes, you get paid!), your office, travel, some due diligence, and your general operating expenses during the search. In exchange, your investors typically get a 50% step-up on that search capital and a pro rata right of first refusal on participating in the acquisition phase (step 3 below). This process can take 2-8 months, depending primarily on your geographical location, your network, and your fundraising abilities.
2. You search for your business. Most searchers refer to his phase as "the grind." You're scouring industries, prospecting thousands of companies, qualifying and moving them through your sales funnel, and negotiating until you finally find someone willing to sign on the dotted line. This takes on average about 2 years, though it has taken searchers anywhere from 1-3 years.
3. You raise the acquisition capital. You've found a great business willing to sell to you! Now you need to find the money. You will likely raise several million of equity capital and several million of debt capital. The equity capital will likely come mostly from your search-phase investors, and your debt capital may come from banks, mezzanine lenders, or the seller. This process happens in tandem with your due diligence efforts and can take anywhere from a month to a year, with an average of 3-4 months.
4. You buy the business. Your capital is raised, your diligence is nearly complete, and it's time to sign the papers and transition into the CEO role. It's what you've dreamed of doing since the beginning! But wait… there's the fifth phase.
5. You operate the business. As much as it feels like you've reached the finish line when you buy the business, the acquisition is really just the beginning of your journey. The operational phase is where you'll face most of your challenges and opportunities, and it's where you'll either create or destroy value for your shareholders. (Prospective searchers tend to worry too much about the search phase and not enough about the operational phase.) This phase typically lasts anywhere from 4-10 years.
6. You exit the business. At some point, at least some of your investors will want liquidity. If you're doing well, others may choose to stay on, and you may stick around as well. Some searchers opt to stay with the business indefinitely. Others move on to other projects; they either look for another acquisition, start a business, and/or become investors, often with a focus on the search fund model. Preparing the business for sale and successfully selling it can take a year or more when done right.

So you think you want to launch a search fund? Do your diligence first.

This is not a short journey, and for many searchers it's happening in the prime years of their careers. It makes sense, therefore, to do your homework.

A good preparation recipe for a prospective searcher includes the following elements:

1. Read the Stanford Search Fund Primer. Stanford GSB publishes this primer every couple of years, outlining trends, figures, and collective advice in the search fund world.
2. Check out the SMEVentures reading list.
3. If you're searching outside the US, you might also want to read IESE's study on search funds. This also comes out every couple of years.
4. Attend a search fund conference. There are several annual conferences these days, hosted by Harvard Business School, IESE, University of Chicago Booth, Northwestern Kellogg. There are rumored to be others on the horizon.
5. Speak to searchers - current and past, successful and unsuccessful.

I also encourage you to schedule a call with me. I'm happy to guide you through the process!

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