A search fund is a proven, viable method for an entrepreneur or team of entrepreneurs to own and build a company.
Search fund entrepreneurs self-select. They are resourceful, well-educated self-starters who know one thing: they want to be their own boss.
If you want to be a CEO, build a substantial enterprise, and create significant wealth for yourself, the search fund path is for you.
The search fund model offers relatively inexperienced, recent MBA graduates with limited capital resources a quick path to owning, managing, and growing a company.
Forming a search fund starts with conversations between you and prospective search fund investors. You want to talk with investors and operators that can provide capital, but more importantly, advice and guidance during your entire search fund journey.
Your goal is to select a group of six to ten professional search fund investors and operators to be value-added partners for the next five plus years.
These investors will each provide a portion of the initial search capital, typically between $400,000 and $500,000. This capital will be used to pay your salary, travel expenses, and any administrative expenses during your search. With this capital , you will be able to operate a search for approximately 24 months (the median months to acquire a company is 19.3 according to the 2018 Search Fund Study). At the time of acquisition, these investors have the right of first refusal to provide the necessary equity to fund the transaction.
After a few initial conversations with prospective investors, you should create a Private Placement Memorandum. This written document outlines the specifics of your search fund with an emphasis on your search strategy, acquisition criteria, and sample industries. Be thoughtful about the search strategy, acquisition criteria, and sample industries because it will be examined closely.
Alignment of search strategy and investment philosophy are extremely important criterion when selecting your investors. Alignment ensures your investors will be attentive during your search and excited to participate at the acquisition.
Mechanically, search funds are usually structured as limited liability companies. After a few initial conversations, investors and existing search fund entrepreneurs can suggest a few well-established law firms in this space. These firms will provide all the necessary legal aid.
Searching, as it sounds, is about finding a company that you will run as CEO. You will spend your time learning about new industries and talking with CEOs/owners. Your goal is to convince one owner to sell their business.
Searching is a daily battle of will and commitment; but it's also a proven, viable approach that works. The 2018 Stanford Search Fund Study shows that 69 percent of search funds acquire a company. The odds are in your favor, and there are steps you can take to increase them further.
First, industry searches maximize your short-term and long-term odds of success. In the short-run, every conversation with an industry expert, visit to a trade show, or meeting with an owner is additive. You grow more competent and credible in the industry, which will help you build trust with your eventual seller. Over the long-run, the industry will be the biggest determinant of your success. The larger and faster growing the industry, the more opportunity there is for you to build a great company.
Second, a bias towards action is critical. You are unlikely to buy a company by analyzing from your office. You buy a company by getting face-to-face with owners on a regular basis. A former searcher once said to his investors: "The competitive advantage of the Search Fund model is: 1) the entrepreneurial story; and 2) the willingness to travel quickly."
We understand the search, its risks, and the specific actions you can take to maximize your odds of buying a good company in a good industry.
Generally, you are searching for a high-quality business with the following characteristics:
These characteristics mitigate the operating risk and will allow you flexibility and breathing room as you learn how to operate a business. Additionally, experienced and successful operators and investors will join your board of directors to help you take the already high quality business to even greater heights.
The biggest risk point for a search fund entrepreneur occurs at acquisition. In a sub-optimal situation, search fund entrepreneurs purchase a low growth company. They are stuck and have no room to stretch their managerial muscles or create value. Similarly, search fund entrepreneurs could buy an overly complex business without recurring revenue and quickly get beyond their abilities. It is better to not acquire a business than to acquire a bad business. Failing to acquire is not failure. You have gained deep industry knowledge and developed relationships with CEOs, successful investors, and operators who can help you find another great opportunity.
Professional search fund investors, like Pacific Lake Partners, can help you avoid sub-optimal situations. They have learned from investing behind many search fund companies. Professional investors can help you evaluate potential opportunities and serve as strategic thought partners in your industry and company analysis.
When a target is identified, each search fund investor is given the pro-rata right of first refusal on the equity required to fund the acquisition. Depending on the target company's characteristics, seller debt or bank debt may also be used to support the acquisition, typically representing 20-40% of the purchase price. Purchase prices generally range from $10 million to $30 million, with the equity portion between $6 million and $24 million. The acquisition is expected to be at fair market value based on the growth profile, quality of the business model, and size of the company.
This is the fun part. You will spend the next five plus years learning the business, leading people, and creating value. The investors and operators you choose while fundraising will coach and support you as you grow as CEO.
In the first year to eighteen months after the acquisition, you will likely make no radical changes to the existing business, opting instead to gain familiarity with the company and your new role. After gaining comfort and understanding, you might begin to make changes and grow the business. Each operating situation is unique, but all are incredibly rewarding.
According to the 2018 Search Fund Study published by Stanford Graduate School of Business' Center for Entrepreneurial Studies, 69% of search fund entrepreneurs acquire a company. In the operating phase, according to Stanford, 71% of search fund companies make money. In our experience, four out of five will make money, with three out of five on or above their base case plan.
This is a personal decision. We invest in solo entrepreneurs and partnerships and have seen success with both. Roughly, 45% of search fund entrepreneurs have a partner.
That said, the most recent Stanford study suggests correlation (not causation) between partnership Search Funds and top quartile outcomes...but we believe it's not that simple. There are unexplained, fund-level dynamics at play (e.g., an entrepreneur's listening skills, tendency to seek advice, and ability to detect good from bad guidance) that affect its eventual outcome.
At the end of the day, it's your call to make. If an entrepreneur does choose the solo route, a way to hedge oneself from this phenomenon is to hire another recent MBA graduate or experienced operator early after acquisition.
Our experience overwhelmingly suggests that the quality of the company one buys and the industry in which it operates are the most influential factors in the entrepreneur's eventual outcome. Third most is the size of the acquired company; the bigger the better.
An industry focused search improves your odds of buying a good company. In an industry search, every interaction is additive, increasing the searcher's knowledge base. The searcher builds confidence and credibility that engenders trust with the eventual seller who decides to sell her/his business to the entrepreneur.
After acquisition, the bigger and better the industry, the more opportunity there is for a resourceful entrepreneur to build a meaningful company.
While you search and operate, you will be paid a salary commensurate with your experience and location. Typically, we see searcher salary around $130,000, and CEO salary is around $180,000, which will grow as you gain experience.
Our experience overwhelmingly suggests that the quality of the company one buys and the industry in which it operates are the most influential factors in the entrepreneur's eventual outcome. By limiting your search to a tighter geographical area, you lower your chances of finding a high quality business. Further, it becomes difficult to conduct an industry driven search process as many of your targets will be outside of your geographical region.
There have been many successful searchers that had a tight geographic region, but we believe that it greatly limits your ability to find a high quality business in a growing, attractive market.
No! Take a sample of search fund companies and their locations. You will find the companies are in major cities with access to talent and customers: New York City, Boston, San Francisco, Houston, Charlotte, Denver, and Los Angeles. While we would happily invest in a great company in any location, we would be surprised to find one in the middle of nowhere.
Yes! As an entrepreneur, you offer more than a transaction. You are going to inherit the owners business and continue to build their legacy. You allow them to retire or work on their passion projects. You are a unique buyer whom they recognize as a younger version of themselves.
We advocate paying a fair price for a quality business, and recent acquisitions have been completed at 5-7x EBITDA.
This is the toughest question that we get asked, but our criteria are both objective and subjective. Among the objective criteria, we look at your search strategy, industries of interest, screening criteria for an attractive company, and your proposed terms. Among the subjective criteria, we focus on your past experiences, your motivations behind pursuing a search fund, your demonstrated history of resourcefulness or entrepreneurship, and your willingness to listen.
There is no "silver bullet," but a great entrepreneur who is driven, willing to listen, and who buys a solid company in an attractive industry is likely to succeed. A strong board can keep the entrepreneur from making any “body blow” mistakes early on while he or she learns how to manage and grow an organization.
Decide if this is the path for you.
The search fund community is very welcoming. We, and the entrepreneurs that have gone before you, want to help you. Find them (both searchers and operators), reach out, and listen.