Investors who try to diversify their holdings away from traditional private equity may want to see the search fund. Although these funds started in the mid -1980s, they have gained traction in recent years as the number of funds has increased rapidly and returns have been constantly attractive. This blog looks at the search funds – what they are, how they differ from private equity, and why they should be on the radar of some investors.
What are search funds?
A search fund is an investment vehicle formed to find, obtain and operate a closely held business. The fund uses predetermined investment criteria, such as minimal Ebitda and revenue, industry and geography. In 1984, funds were conceived in 1984 by MBA class of management MBA class at Stanford University’s Graduate School of Business, 1984. Since then, over 700 search funds have been introduced, which has been creating a complete ecosystem known as entrepreneurship through acquisition (ETA). Now search funds are running in Europe, Latin America and Asia.
There are two primary types of search funds: self-funded and traditional models. A third, relatively new model, independent sponsor model, has begun to receive traction.
In self-funded models, an entrepreneur uses savings and family contribution to fund expenses such as marketing, membership and travel. Term loans and government-supported programs usually fund the acquisition that depends on the market in which the entrepreneur operates. However, most self-funded entrepreneurs are partners to finance the equity part of the deal with many investors.
Under the traditional search fund model, the most prevalent, an entrepreneur raises capital by selling investors to units. These units represent an equity stake in the search fund of the entrepreneur. Capital covers search-related expenses for 24 to 36 months. Investors who buy units at this stage gain authority, but not the responsibility of participating in the funding of acquisition. Outside investors, before the entrepreneurial approach, they will have the right to refuse to finance the entire equity part of the acquisition. A Board of Advisors provide guidance and support during the search phase and a complete directors board after the acquisition.
The acquisition after the investment horizon ranges from four to seven years. Recently, however, search funds have adopted a long -term grip strategy to maximize value construction. Search Fund Ecosystem is being run by major business schools like Dordon School of Business, Harvard, Stanford’s GSB and Chicago Booth School of Business University. These schools identify the search funds, can be taken to become CEOs of small businesses as a path graduates.
Search funds target small-to-middle-sized businesses (SMBs) in unwarded markets, often created opportunities in areas ignored by private equity funds. Unlike private equity, which targets large businesses with high competition, search funds work below where the evaluation is low, and the deals are lower election fought. PE funds also invest in many companies, while search funds are designed to invest in the same company. Many search funds target businesses that serve local or regional markets, providing important goods or services that can be increased with proper management. Ideal acquisitions are companies that consistently produce positive cashflows, including recurring revenue, low customer churning, minimal Ebitda of $ 1 million, low risk for external risks and a strong management team. The opportunity is contained in the value construction capacity of the search fund.
The latest type of search fund is independent sponsor model. This model allows entrepreneurs to carry forward the acquisition without extending traditional search fund upfronts. Instead of acquiring committed capital before searching, independent sponsors identify and interact the first deals, then increase equity and debt financing from investors on the basis of deal-by-Deal. This approach provides flexibility, enables explorers to take advantage of their network and expertise by aligning investor interests with specific opportunities.
Price proposal
Stanford Graduate School of Business 2024 Search Fund Study (Figure 1) analyzed 681 search funds formed in the US and Canada since 1984. The funds reported a return of 35.1% returns (IRR) and return to 4.5x investment (ROI). Constant performance over decades, despite changing macroeconomic conditions, explore the flexibility of the search fund model and long-term value-making capacity.
Figure 1 | IR and ROI in the year of company acquisition,
Search funds provide a compelling investment model by basically aligning with long -term, strategic purposes of most investors that prefer permanent growth on quick exit. Unlike traditional private equity, search funds emphasize the entrepreneurial value construction post-acquisition, dedicate themselves to manage and value-added activities that increase professional efficiency and profitability, resulting in strong operational performance. The search funds target the target by reducing small-shaped businesses, which unlock unique opportunities in unwarded areas with significant growth capacity. This combination of alignment, operational focus, and access to unused markets is a search fund for investors looking for both financial returns and permanent impact.
Given the role of business schools, there are opportunities for family offices and institutional investors to partner with MBA programs, which help cultivate a pipeline of skilled operators while making search funds, the structured program that offers capital, maintenance and network can make the ecosystem professional and reduce the risk.
Future
The search fund model is gaining momentum with increasing adoption in Europe, Latin America and Asia, with increasing interest of traditional private equity from institutional investors. This reflects the appeal of the expansion model: high potential returns from the talent of entrepreneurship in the underscribed markets. Technology is ready to accelerate this trend because AI and data-operated equipment funds fund the search process. The search fund will benefit from the operation of post -acquisition by rapid target identification, proper diligence, and post -acquisition through efficiency analysis and efficiency benefits.
The search funds stand out as a valuable alternative asset class, offering diversification, alpha capacity and upside down in operating markets. Their low capital requirements, value construction on hands, and lordes with long -term investor goals make them a compelling counterpoint for traditional private equity. In addition to their investment capacity, the search funds represent the opportunity to refund the talent of entrepreneurship and how to reopen it in private markets.