by: Dan Baker & Evan Metzger
For aspiring entrepreneurs who want to run their own business but don’t have a startup idea or desire to build from scratch, there’s another path: the search fund model. Created in 1984 by H. Irving Grousbeck at Stanford Business School, search funds offer a unique approach to entrepreneurship through acquisition. In the following, we’ll explain how search funds work, the benefits of choosing this entrepreneurial path, key factors in a search fund’s success, and recent trends in the search fund ecosystem.
How Search Funds Work
A search fund is an investment vehicle that allows aspiring entrepreneurs (known as “searchers”) to search for, acquire, manage, and grow an existing small business. Here’s how the process typically works:
1. Initial Fundraising: The searcher raises capital from investors to fund a dedicated search period, usually 18-24 months. This initial capital (typically $400,000-$500,000) covers the searcher’s salary and search expenses.
2. The Search: The entrepreneur systematically looks for businesses that meet specific criteria, often focusing on companies with:
- $10-30 million in revenue
- $1.5-5 million in EBITDA (earnings)
- Sustainable competitive advantages
- History of stable cash flows
- Strong growth potential
- Relatively straightforward operations
3. Acquisition: Once a suitable company is identified, the searcher raises additional capital from the same investors to fund the purchase, typically combining investor equity with bank debt and seller financing.
4. Operations: The searcher becomes CEO of the acquired company and runs it with the goal of creating value through growth and operational improvements.
Why Choose the Search Fund Path?
Many ambitious business leaders follow a path of progressive leadership, rising up in the ranks at established companies before becoming an executive. Others might short cut that route by joining a promising startup, where 20-something year olds are not uncommonly part of the C-suite. Search Funds offer an alternative path to people with an entrepreneurial streak who want to avoid the lengthy route to leadership at a large corporation or the pain (and risk) of a startup. Here are some of the advantages of going down the search fund route:
- Leadership Opportunity: Searchers get to run their own company much earlier in their careers than they might otherwise.
- Financial Potential: Search fund principals typically receive 20-30% ownership in the acquired company through a structured equity package that vests over time and based on performance.
- Risk Mitigation: Compared to startups, acquiring an existing profitable business with proven operations can reduce some entrepreneurial risks.
- Support System: Search fund investors often have extensive experience and can provide valuable guidance throughout the process.
Key Factors in a Search Fund’s Success
Based on Stanford’s research and experienced search fund investors, several factors contribute to success:
1. Searcher Characteristics
- Strong attention to detail
- Persistence through rejection
- Relationship-building ability
- Leadership potential
- Willingness to seek and accept advice
2. Search Process
- Systematic approach to finding opportunities
- Thorough due diligence
- Disciplined investment criteria
- Strong network development
- Effective negotiation skills
3. Post-Acquisition
- Clear communication with stakeholders
- Focus on learning the business before making changes
- Strong governance practices
- Balanced approach to growth and risk management
The Track Record
Search funds have demonstrated compelling returns as an asset class. According to Stanford’s research, search funds have historically generated an aggregate ROI of 5.5x and an IRR of 32.6%. However, returns vary widely, and approximately one-third of search funds fail to acquire a company despite dedicated searching.
Challenges and Considerations
The search fund model isn’t without its challenges:
- Time Pressure: Searchers typically have 18-24 months to find and close a deal while managing investor expectations.
- Competition: Searchers often compete with strategic buyers and private equity firms for attractive deals.
- Experience Gap: Most searchers are relatively young and inexperienced as CEOs, which can create challenges in negotiations and early leadership.
- Geographic Flexibility: The best opportunity might require relocating to a new city or region.
Recent Trends in the World of ETA
The search fund model has evolved since its inception:
- Growing Popularity: The number of search funds has increased dramatically, from 20 in 1996 to over 400 by 2020.
- Diverse Backgrounds: While traditionally popular among recent MBA graduates, the model now attracts mid-career professionals and those from varied backgrounds.
- International Expansion: Search funds have spread beyond the U.S. to international markets.
- Professional Investors: A growing ecosystem of professional search fund investors provides both capital and expertise.
Is a Search Fund Right for You?
The search fund model might be a good fit if you:
- Want to run your own business but don’t have a startup idea
- Have strong leadership potential but limited CEO experience
- Are willing to relocate for the right opportunity
- Value having experienced investors as mentors
- Can handle significant uncertainty during the search phase
- Are comfortable with a longer-term value creation approach
However, it might not be ideal if you:
- Have a specific startup idea you’re passionate about
- Need complete autonomy in decision-making
- Can’t handle extended periods of uncertainty
- Are unwilling to relocate
- Prefer building something from scratch
The search fund model offers a unique path to entrepreneurship that combines the excitement of running your own business with the stability of an existing operation and the support of experienced investors. While not without its challenges, it has proven to be a viable alternative to traditional entrepreneurship for many ambitious business leaders.
Search Fund Accelerators
Recent years have witnessed the emergence of a new trend in the Entrepreneurship-Through-Acquisition ecosystem. Rather than independently raise funds, sniff out potential deals, perform the diligencing and enter negotiations, many aspiring business owners are turning to search fund accelerators. These specialized organizations provide structured support, mentorship, and committed capital to searchers while streamlining the acquisition process. Pioneered by Search Fund Accelerator in 2015, this model has evolved to include various approaches, from cohort-based training programs to operator-centric private equity structures, all designed to increase searcher success rates and optimize the traditional search fund model that has historically seen high failure rates.
Search Fund Accelerator (SFA)
Founded by Timothy Bovard in 2015, Search Fund Accelerator (SFA) was the first search fund accelerator, designed to optimize the traditional search fund model. SFA provides unparalleled support and committed capital to handpicked cohorts of entrepreneurs seeking to acquire and manage companies as equity-owning CEOs.
Based in New Orleans and Denver, SFA aims to dramatically increase searcher success through extensive coaching, resources, and support. To date, SFA has worked with 46 searchers across ten cohorts, all sharing “the drive and determination to be successful CEOs.”
Learn more about SFA at www.searchfundaccelerator.com.
Broadtree Partners
Broadtree Partners is a premier micro-cap and lower middle-market private equity firm headquartered in Charlotte, North Carolina, founded in 2016. Co-founded by David Slenzak and Jason Hull, Broadtree positions itself as “halfway between a search fund and an operator-centric private equity fund model,” where searchers are employees of Broadtree for the duration of the search period.
Broadtree provides mentorship and support to their searchers throughout all aspects of the process, from sourcing and pre-acquisition negotiations to the value creation process. The firm focuses on acquiring companies with $1-10MM EBITDA.
To learn more, visit www.broadtreepartners.com.
Dan Baker is a Director at ECA Partners. He can be reached at [email protected]. Evan Metzger is a Project Manager at ECA Partners. He can be reached at [email protected].
