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explore how search funds work and why they are becoming a popular avenue for entrepreneurs
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Most common questions about Search Funds
A search fund is a type of investment vehicle typically used by entrepreneurs to find, acquire, and manage a single small-to-medium-sized business. The entrepreneur (known as the “searcher”) raises capital from investors to fund the search and acquisition process. Once a business is acquired, the searcher takes on an active role in running the company.
In contrast, a private equity (PE) fund pools capital from a range of investors to acquire multiple businesses, often larger and more established companies. PE firms typically take a more hands-off approach, hiring management teams to run the acquired businesses, with a focus on optimizing operations and achieving a profitable exit, usually within a few years.
The key differences are:
- Number of Acquisitions: A search fund typically focuses on one acquisition at a time, whereas private equity funds acquire and manage multiple companies.
- Size of the Target Business: Search funds typically target smaller, growing businesses (often with revenues between $5M and $30M), while private equity funds tend to target larger, more established companies.
- Role of the Entrepreneur: In a search fund, the entrepreneur actively runs the acquired company, whereas in a private equity fund, the firm usually focuses on oversight and financial performance, leaving day-to-day management to a separate team.
Searchers who are industry agnostic often look at businesses across a variety of sectors, but they focus primarily on the following criteria when evaluating potential acquisitions:
1. Stable and Predictable Cash Flow:
- Searchers seek businesses that provide reliable revenue streams, which reduces the risk and makes the business easier to manage.
- Example: A commercial cleaning service providing routine cleaning contracts with stable customers or a small HVAC company with long-term service agreements.
2. Strong Market Position with Competitive Advantage:
- A company with a strong brand, customer loyalty, or operational efficiency is ideal, as it makes it easier for the searcher to maintain and grow the business.
- Example: A regional plumbing company with a strong reputation or a specialty food supplier with a unique product that’s hard to replicate.
3. Low Customer Concentration:
- Businesses with a diversified customer base are attractive because they reduce risk by avoiding overreliance on a small number of clients.
- Example: A manufacturing company with a wide range of clients in different industries, or a business services firm that serves various sectors.
4. Opportunity for Operational Improvements:
- Searchers look for businesses with inefficiencies or untapped growth potential that can be improved with better management or additional investment.
- Example: A local distributor with outdated systems that can be modernized or a construction business that hasn’t yet expanded to new markets.
5. Recession-Resistant and Resilient Business Model:
- Searchers typically prefer industries that perform well regardless of economic cycles, ensuring the business can survive downturns.
- Example: A healthcare-related business (e.g., medical device repair), senior care services, or grocery stores which provide essential services that people need regardless of the economy.
6. Scalability:
- Businesses that can grow quickly, either regionally or nationally, often have an advantage for searchers looking to expand.
- Example: A franchise-based business, a software-as-a-service (SaaS) platform, or a pet services business with room to expand to new locations.
7. Low Technology Risk:
- Searchers tend to avoid businesses that depend on rapidly changing technologies or need significant tech investments to stay competitive.
- Example: A logistics or transportation business that can scale with efficient processes rather than needing constant tech upgrades, or a printing business that serves steady demand with minimal technological disruption.
By focusing on these criteria, industry-agnostic searchers can find opportunities in a variety of industries, such as manufacturing, distribution, business services, healthcare, home services, and consumer products.
Here are the top 5 methods searchers typically use to find a business to buy:
1. Direct Outreach (Cold Calling and Networking):
Proactively contacting business owners, brokers, and industry professionals to uncover businesses that may not be actively listed for sale.
Example: Cold-calling owners of small businesses approaching retirement.
2. Business Brokers and M&A Advisors:
Working with brokers and advisors who specialize in connecting buyers with businesses for sale, offering a curated list of opportunities.
Example: Partnering with brokers in industries like manufacturing or healthcare.
3. Online Marketplaces:
Using online platforms such as BizBuySell or BizQuest to browse businesses for sale based on criteria like industry, revenue, and location.
Example: Searching on BizBuySell for small service-based businesses.
4. Industry Conferences and Trade Shows:
Attending events to network with business owners who may be interested in selling, as well as gaining industry insights.
Example: Attending a manufacturing conference to meet small business owners.
5. Networking with Professionals:
Building relationships with accountants, attorneys, and financial advisors who may be aware of business owners considering selling.
Example: Collaborating with a tax advisor who works with owners planning for succession.
People often ask about the typical timeline for finding and acquiring a company, as search funds usually take 1-2 years to locate a target.
The primary difference between a self-funded search and a traditional search lies in how the capital for the search and acquisition is raised, as well as the ownership structure:
Capital Raising:
- Traditional Search: In a traditional search fund, the searcher raises capital from a group of institutional investors (such as high-net-worth individuals, family offices, or private equity firms) to fund the search and acquisition process. This capital covers the entrepreneur’s salary, search expenses, and acquisition capital.
- Self-Funded Search: In a self-funded search, the searcher raises capital independently, often through personal savings or by leveraging their own network, without relying on external institutional investors. This means the searcher typically funds their own salary and the costs associated with the search phase.
Ownership:
- Traditional Search: The searcher shares ownership of the acquired business with the investors who funded the search, so the searcher typically holds a smaller percentage of the company after acquisition.
- Self-Funded Search: Since the searcher raises their own capital and does not have external investors, they retain a larger ownership stake in the acquired business, often a majority share, after the acquisition.
Risk and Rewards:
- Traditional Search: The searcher bears less financial risk during the search process, as the investors fund the search phase. However, the entrepreneur must share the potential upside with the investors.
- Self-Funded Search: The searcher assumes more financial risk during the search process, as they are using their own resources to fund the search and acquisition. However, they retain a larger share of the rewards once the business is acquired.
Control:
- Traditional Search: In a traditional search, the searcher’s decisions are often influenced by the investors who provide the capital, and the entrepreneur may need to involve them in major decisions.
- Self-Funded Search: The searcher has more control and autonomy over the entire process since they are not answerable to outside investors.
In essence, a self-funded search offers the entrepreneur more ownership and control but comes with greater financial risk, while a traditional search provides external funding and shared ownership in exchange for less control.
The typical deal structure for a search fund acquisition usually includes:
Equity: The searcher usually acquires 100% of the business equity, often with the support of investors.
Debt Financing: The deal often includes debt, either from a bank or the seller (seller financing), to help fund the purchase price.
Seller Financing: Part of the purchase price may be paid over time through seller financing, with the seller receiving regular payments.
Earnouts: A portion of the purchase price may be contingent on the business meeting certain performance targets post-acquisition.
Investor Equity: Investors typically receive equity in the business, with the searcher maintaining control (often 20-30%).
The exact mix of debt and equity depends on the deal, but the structure balances risk between the searcher, investors, and the seller.
The search fund acquisition process typically involves the following steps:
1. Raising Capital
Initial Fundraising: The searcher raises capital from investors to fund their search for a business. This usually covers the costs of the search and the acquisition itself.
Investors: These may include individuals or institutions that provide funding in exchange for equity in the future acquired company.
2. Searching for a Business
Deal Sourcing: The searcher spends 1-2 years finding a suitable business to acquire. This involves identifying potential targets, often using brokers, networks, and direct outreach to owners.
Criteria: Businesses typically need to be profitable, in a stable industry, and have room for growth or operational improvement.
3. Evaluating Targets
Due Diligence: Once a potential target is identified, the searcher conducts thorough due diligence, including financial, operational, legal, and market evaluations.
Financial Models: The searcher builds financial models to assess the value of the business and ensure it meets acquisition criteria.
4. Negotiating the Deal
Structure & Terms: The searcher negotiates the price, terms, and structure of the deal with the seller. This may include earnouts, debt, and equity components.
Letter of Intent (LOI): If the terms are agreed upon, an LOI is signed, outlining the basic terms of the transaction.
5. Securing Financing
Debt & Equity: The searcher arranges financing for the acquisition. This could include seller financing, bank loans, or additional capital from investors.
Capital Raise: In some cases, the searcher may raise more capital from investors to help fund the deal.
6. Closing the Deal
Final Agreements: Legal documents are signed, including purchase agreements and financing agreements.
Ownership Transition: The searcher takes control of the business, often with support from the previous owner during the transition period.
7. Post-Acquisition Integration
Management: The searcher implements operational improvements, drives growth strategies, and manages the company moving forward.
Exit Strategy: Over time, the goal is typically to increase the business’s value, either for an eventual sale or other form of exit.
This process typically takes around 3-5 years from search to acquisition and post-acquisition integration, with the search phase lasting about 1-2 years.
Searchers come from many different backgrounds and have different skill sets. Here are the broad skills we see
Financial & Analytical Skills: Background in finance (e.g., investment banking, private equity) with strong proficiency in financial modeling and analysis.
Entrepreneurial Mindset: Ability to identify opportunities, take risks, and adapt quickly. Experience in business management or startups is beneficial.
Industry Expertise: While industry agnosticism is common, having sector knowledge in areas like manufacturing, healthcare, or tech can be advantageous.
Leadership & Management: Experience in leading teams, managing operations, and driving growth post-acquisition.
Communication & Negotiation: Strong verbal and written communication skills for dealing with investors, business owners, and brokers.
Resilience & Perseverance: Ability to handle setbacks and stay motivated through the challenging search process.
Educational Background: A business-related degree (MBA, finance, economics) is common, with additional certifications like CFA or CPA being beneficial.
Networking: Strong relationship-building skills to source deals and connect with industry professionals.
Understanding of the Search Fund Model: Familiarity with deal structuring, fundraising, and execution.
Successful searchers combine financial expertise, entrepreneurial spirit, leadership, and resilience to navigate the search fund process.
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Most popular resources for searchers
Explore the most popular and valuable resources—including books, podcasts, and newsletters—that provide searchers with insights, strategies, and inspiration throughout their journey.
Search funds are great!
Look how many people were at the self-funded search conference in September of this year! There is a lot of knowledge in that room!
