Search Funds 🔍

Author

Owen
October 18, 2024

In partnership with

Welcome to Alternate Universe!

In today’s edition:

  • In search of search funds 🔍

  • Job opportunities at recently funded European startups 👇

  • Google going nuclear ⚛️

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The Crux 🔴

Podcasts - it seems like everyone and their dog has one these days, yet few are memorable. There are only a handful of shows I follow religiously, including My First Million.

Last November, they aired what I think is their best episode yet—a story of unbelievable hustle and resilience.

The star of the show? Sarah Moore, a troubled teen who managed to get into Harvard Business School and, while still studying, bought a multi-million dollar egg carton business for $0.

Sounds crazy, right? You can catch the full episode here.

Part of the story dives into how Sarah pulled this off using a search fund—a pretty unconventional path to business ownership.

You know what that means—it’s time for another rabbit hole.

Let’s dig in.

🐰🕳️⌚

What? 🤔

A search fund (aka Entrepreneurship by acquisition) is an investment structure established by one or two entrepreneurs, known as searchers, who secure funding from a pool of advisory investors. This financial arrangement is designed to assist them in identifying, purchasing, and managing a privately owned company for an extended period, typically from medium to long term.

Research by IESE Business School, compares the search fund model to a 3-legged stool.

  • Jockey = searcher or search fund entrepreneur; typically MBA graduates

  • Trainer = search fund investor with operational experience

  • Horse = company

In contrast to private equity, the operators of a search fund actively engage in running the acquired business post-acquisition. Additionally, the management team frequently benefits from the investors’ guidance.

Over 500 search funds have been formed since 1984 with Stanford and IESE reporting on US and international searchers respectively.

How? 🛠️

Search funds have 4 distinct stages.

  1. Raising capital

    Search fund entrepreneurs start their fundraising process by developing a Private Placement Memorandum (PPM), outlining the investment opportunity to potential search fund investors. A typical PPM structure can be found here.

    Search capital is needed to cover the searcher’s salary and administrative costs. Once a suitable target company is identified, a larger amount of funds (‘acquisition capital’) will be needed to close the deal.

    Ideal search fund investors provide operational experience and network introductions. Want to get a list of search fund investors? Hit subscribe and reply to this mail for a curated list.

  2. Search & company acquisition

    Streamlining the search process requires a criteria list for evaluating target industries and companies. Over the years, the search fund community has done a good job of crafting a suggested list. The acquisition capital structure may include debt, equity (common & preferred), and seller financing.

  3. Operation

    Post-acquisition, searchers tend to instill a board of directors to aid in the transition. During the initial six to 18 months, searchers focus on getting acquainted with operations instead of making major changes. Value can be created through operational efficiency, revenue growth, and acquisitions.

  4. Exit

    Exit times vary between 4-7 years although investors and principals can agree on longer time horizons. Liquidity can occur either through dividend distributions, IPO or sale to a strategic buyer.

Why? ⁉️

Search funds are attractive for several reasons. They offer relatively inexperienced professionals the chance to own and manage a small business. Revenue and profits are generated immediately instead of waiting months or years to break even in a startup.

Above-average returns for both investors and searchers are one of the biggest selling points for search funds. According to Stanford data, returns for all searches in the US and Canada from 1986 to 2021, had pre-tax returns of 35.3% IRR and 5.2x ROI. In comparison, the top quartile of VC and PE funds in the US, averaged 28% and 13% returns, respectively, over the last 25 years, according to Cambridge Associates data.

One of the biggest tailwinds for ETA is the growing supply of small businesses held by aging owners, without a proper succession plan. In Japan, one third of SMEs are controlled by people aged over 60. Japanese bank, Nomura, has launched a fund to help such companies, enlist young executives as CEOs.

On the flipside, search funds pose unique risks. Searchers’ limited operational experience can jeopardize the business’ future. Searchers might also exhaust initial search capital before concluding an acquisition. Additionally, if the acquired company does not perform well post-acquisition, there is a limited market for selling private shares.

Investment Implications 🤑

Returning to the stool analogy, there are three main ways to get involved in this niche asset class:

Become a Jockey

The Entrepreneurship Through Acquisition (ETA) pathway is becoming increasingly popular among MBA graduates. In fact, according to IESE’s latest survey, 86% of international search fund principals hold an MBA. These searchers come from diverse professional backgrounds, with nearly 40% having experience in private equity or management consulting in 2020-2021.

ETA can be highly rewarding, but it also demands a long-term commitment. Prof. Wasserstein at the Yale School of Management has outlined eight critical questions that aspiring search fund entrepreneurs should consider before taking the plunge.

Invest in a Jockey

Investing in a search fund is more complex and generally inaccessible for passive investors. Most search fund investors have walked the same path themselves, successfully exiting multiple businesses. Their deep understanding of the risks involved allows them to support search fund entrepreneurs in navigating these challenges.

In addition to professional investors, searchers often seek backing from executives, high-net-worth individuals (HNWI), and entrepreneurs—people who are business-savvy but might not be as familiar with the search fund model.

Sell Your Business

Lastly, if you own a business in a target industry and are considering selling, ETA offers an appealing exit strategy. According to a Stanford survey, 96% of sellers reported a positive relationship with the searcher post-acquisition.

Dig Deeper ⛏️

P.S. Liking this issue? Forward to a friend 🧑‍🤝‍🧑

Headhunted 🦅

Recently funded private companies need talent! Scout jobs at recently funded European startups, ahead of your competition. 💪

  1. Constellation Technologies 🇫🇷 - The French startup has raised a €9.3m round to deliver high-speed internet from space. Engineering roles available (link)

  2. Stoik 🇫🇷 - Insurtech company closes a €25m Series B round. Hiring a product designer and a sales expert (link)

  3. CorPower Ocean 🇸🇪 - The pioneer in wave energy technology has closed a €32m Series B1 round. Engineering roles available (link)

  4. Antiverse 🇬🇧 - The AI-driven antibody discovery startup closed a €4.2m seed round. Hiring a senior ML engineer (link)

  5. Bacta 🇫🇷 -The biosynthetic natural rubber startup has raised a €3.3m in a pre-seed round. Hiring an analytical chemistry intern (link)

Interestingness📔

📚 New to investing? Grab a PDF copy of my ebook here.

As always, the financial disclaimer!

This is not investment advice. I am not a financial advisor. Make sure to conduct your thorough research before purchasing or selling financial products.