Search funds – an alternative for the future entrepreneur (or the exiting one!)
Over the weekend, I caught up with an old classmate of mine and during our conversation, he introduced me to the concept of “search funds”. A search fund is a pool of money that’s primarily used to finance the “search stage” of a business acquisition. This encompasses the following steps:
- Identifying a business to acquire
- Due diligence and evaluation of the target business
- Negotiation of the deal
Search funds are structured organizationally in the same manner as a traditional investment vehicle, with one or more managing partners and several limited partners. The managing partners take the most active role in the search fund, and are responsible for all the steps described above. Limited partners are usually high net-worth individuals who provide the funding for the “search”. In a typical search fund, the limited partners are given the first right of refusal to invest in the target company once it has been identified and vetted. In practice, the majority of the invested capital is raised from the group of original limited partners.
Where search funds differ from private equity (PE) groups is in the focus of the investment. While PEs are generally viewed as “strip and flip” investors, whose goal is to maximize their investment within the shortest period of time, search funds take a longer term view of their investments. The managing partners of search funds become active managers of the acquired business and are focused on running the business much as if they started it themselves. The benefits to sellers of the business include:
1. A possible answer to succession planning issues
2. An exit strategy that allows them to liquidate while preserving the core tenets of the company
For the aspiring entrepreneur(s), a search funds provides the following advantages:
1. Time to evaluate the right industry and company to match his/her/their skillsets and interests
2. The ability to inherit a business that’s already operational and profitable instead of having to start from scratch
Currently, there are approximately 200 active search funds and most were started by business school and law school graduates. However, the concept should be intriguing for anyone who would like to own and operate their own business, but do not want to start from scratch. For more information on search funds, please check out the table and the links below:
Stanford Graduate School of Business search fund page
Interview with some search funders
I’d like to thank Andrew Matricaria at Lakeshore Capital Partners, LLC for his detailed and patient explanation of search funds.
