What Is a Search Fund?

A search fund is an investment vehicle, created in 1984, to help connect investors with entrepreneurs and manage a newly created company. The funds are usually set up by one or two entrepreneurs who raise investment funds from different venture capitalists to find suitable investment opportunities. The creation of a search fund is generally accredited to Professor H. Irving Grousbeck from Stanford Graduate School, who created the model to help two students who were looking to raise funds for buying a business. 

A search fund makes it possible for entrepreneurs to connect with investors and raise equity investments. There are different stages of the development of the search fund, such as:

  • Raising the initial capital
  • Finding an acquisition deal of companies valued between $5 million and $30 million
  • Managing and growing the business
  • Exiting the investment when it is the right time to do so

Search Fund: Explained

A search fund can be defined as a pool of money that is raised by one or two people who want to buy a company and manage it for profit. The business model is based on the increasing interest among young entrepreneurs to buy and manage their own companies as CEOs in order to make money on the services provided, such as finding acquisition target companies and securing deals. 

On average, it takes 19 months to locate and acquire a company, and then raise around $425,000 in search capital. The main targets of search fund acquisitions are businesses where the owner is looking to retire or there is a war among co-founders. The return of investment is around 30 percent, making it more lucrative than starting a business from scratch. Search funds have a significantly higher success rate than newly created ventures.  

The development of search funds started slowly in the mid-1980s, and their number grew quickly during the '90s and 2000s. Today, alternative models of search funds are being developed by innovative entrepreneurs. Many look for partnerships initially, instead of simple capital investment. 

According to Entrepreneur Magazine, one of the main challenges of managing search funds is related to the uncertainty of markets. Another is the required investment of time, knowledge, and experience in locating the businesses that can be operated for profit in a short period of time. The goal is a strong return on investment for investors and income for search fund owners. 

Search funds and similar models are now being used by acquisition advisors around the world to help them identify risks and opportunities. 

The operators of a search fund include:

  • Business owners
  • Investors
  • Search fund owners or searchers

Why Is a Search Fund Important?

  • Company owners that are looking to sell their business can work with search fund owners and offer them a price their investors will accept. This allows owners to secure their exit strategy. 
  • The investors of the search fund can provide guidance and mentoring for the managers of the company, helping them secure a high return of investment. 
  • Search funds help increase value creation by allowing entrepreneurs to take over struggling businesses and turn them around, without having to establish their own company. 
  • Search funds also help investors make the right acquisition choices and turn undermanaged and low-performing companies into profitable entities. 
  • Young and enthusiastic entrepreneurs are able to fund, manage, and grow companies without having to create one. 

Examples: Using a Search Fund

Business graduates who are looking for entrepreneurial opportunities often set up search funds to find investors and buy established companies. Just like the two students of professor Grousbeck, they often struggle to secure funds that suit their ambition of becoming a CEO of a company. 

Using search funds reduces the risk of starting up a business, as the model and the industry are already present. 

Search funds usually target smaller companies, worth between $5 million and $30 million, and require an equity capital of $2 million to $10 million. The background checks and analyses guarantee the companies chosen have a profitability record and stable background.

Examples: Not Using a Search Fund

Some investors prefer to use acquisition advisors instead of search funds, in order to have better control over their capital and management. Those that do not want search fund managers to have control over the purchased company and assets might not find this solution suitable. 

Search funds are not suitable for startups, and they require a knowledge in the industry in order to create a profitable business model. Entrepreneurs who are looking to start their own company would seek funding using other methods, instead of buying in. 
Search funds are not suitable for companies with a value of more than $30 million, or purchases that require great technological investments. 

Selling businesses to search funds can also be risky for company owners, as generally the owners of funds have limited management experience. 

Frequently Asked Questions

  • Who manages the companies bought through search funds? 

The search fund owners manage the funds until the business is profitable and it is time to exit. 

The search fund finances the search, but it charges investors for the work. 

  • What is the main advantage of search funds over starting a business? 

Search funds reduce the risk of starting a company, as they look for companies that have a potential to be turned around and make a profit. 

  • Are large businesses suitable for search funds? 

According to Professor Richard Ruback  of Harvard Business School, larger companies are not appropriate. Searchers will not have the adequate skills to manage a company of that size.

  • What skills and legal documents do I need to start up a search fund?

You need to be a business school graduate with great analytical skills. For the legal requirements of setting up a venture and raising capital, consult with a professional search fund attorney.

Steps to Acquisition Through Search Funds

  • Raise the search capital: Identifying investors that can help the search fund with experience and advice, as well as capital, is essential. Capital is usually raised by acquiring $350,000 to $750,000 through the sale of shares in the fund.
  • Identify a business: A systematic approach needs to be applied in the search. There will be lots of negotiations, with regards to the purchase of the business, profile, accounts analysis, and finding investors with suitable skillsets.
  • Make an acquisition deal: When making a deal, it is necessary to thoroughly examine the financials, records, and operating environment of the company. It's also important to analyze the investment required, as well as the competition. 
  • Create value by managing the business: Growth of the business can be based on expansion, improvement of services, or effectiveness. Different potential value-creating methods should be tried out. 
  • Exit the investment: Exit strategies are planned for three years ahead, and can be based on selling public shares, dividend distribution, or decapitalization. 

Common Mistakes

One of the main mistakes search fund founders make is not choosing partners and investors with valuable skills in management. Therefore, they do not succeed in creating value. 

Another reason for not being able to create value is the wrong choice of acquisition. Investors should be involved from the beginning, and help the searchers identify potential risks, growth opportunities, and even threats from competitors' potential actions. 

Would you like to learn more about search funds? Talk to one of the top Harvard or Yale graduate attorneys at UpCounsel by posting your legal needs, or check out the search fund resources available.