What is a search fund?

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. 

entrepreneur smiling at conference

Your Path to CEO

The search fund model offers relatively inexperienced, recent MBA graduates with limited capital resources a quick path to owning, managing, and growing a company.

Form
1
Search
2
Buy
3
Build
4
Transition
5

Stage One: Forming a Search Fund

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 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.

Stage Two: Searching

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:

  • Simple Operations
  • History of profits and growth
  • Services (Either B2B or B2C)
  • EBITDA Margins > 15%
  • EBITDA of at least $2m ($2-4m target)
  • 60%+ Contractual Recurring Revenue
  • Low Maintenance Capex
  • Industry Growth of at least 2x GDP

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.

Stage Three: Buying a High-Quality Business

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.

Stage Four: Operating and Creating Value

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.

 

Search Fund CEOs Share Their Story

 

 

Frequently Asked Questions