Most publications credit Irv Grousbeck with the creation of the search fund model and the beginning of search strategies. A former media executive-turned-Harvard professor, Grousbeck created the first search fund in 1984. Search Funds get their name from the initial entrepreneurs who “searched” for companies to acquire with their own capital rather than relying on outside funding sources such as venture capitalists or banks. Since then, search fund activity has grown significantly with more than hundreds successful transactions over three decades.
At Private Market Labs, we consider a search fund to be any small group or individual undertaking a proactive process to find and acquire an existing business based on target factors such as geography, industry, deal size, business type and other criteria. Typically this takes the form of a single-acquisition or multiple-acquisition “search”, where the buyer uses a mix of debt and investor capital to purchase and operate successful small businesses generating meaningful cash flow.
Within the scope of that broad definition, there are various models for executing a search that each offer advantages and disadvantages according to a buyer’s preferences and goals. For instance, the “self-funded” model allows the buyer to maintain significant control, along with material downside in the event that things go wrong. On the other hand, raising money from investors can help a buyer acquire a larger business and spread the financial risk, but comes with additional coordination challenges and less flexibility. Below, we outline several of the most popular search strategies used by buyers in our industry.
Self-funded searches typically pursue debt-focused buyouts of smaller firms using government-backed SBA loans. They tend to acquire smaller companies because the SBA 7(a) program only allows an individual person to obtain a loan up to $5M to purchase a business. Due to the use of leverage and lack of other major equity holders, self-funded buyers maximize their control over the deal sourcing and business operations. This buyer type faces more personal financial risk because utilizing the 7(a) program requires buyers to provide a personal guarantee as collateral. This means that if the business fails, the searcher would be liable to turn over personal savings and assets.
Traditional search strategies, as popularized by Stanford Business School, encourage aspiring owners of small businesses to finance acquisitions with investor capital, often sourced prior to the identification of the investment target. Traditional searchers frequently receive a salary from their investors so they are able to search full-time. In this model, the searcher has less control over the process because they share a larger portion of equity with their investors and need to get investor buy-in for the acquisition. However, this can be offset by the generally larger transaction size. Relative to a self-funded search, the searcher’s personal risk is reduced due to the lack of a personal guarantee on an SBA loan.
Search Fund Accelerator
Search Fund Accelerators support traditional-style searches with additional resources and hands-on guidance, which can increase the chance of a successful search. They are often private equity firms with institutional support systems. Slots to join an accelerator are extremely competitive and there are not many relative to the volume of potential buyers and sellers.
Independent Sponsors (or Fundless Sponsors) also raise capital from investors, but do so differently from traditional search funds and search fund accelerators. Rather than raising investor capital prior to commencing a search, independent sponsors first identify an acquisition target and then raise capital for that specific deal. This provides flexibility relative to the traditional model because the buyer in this case does not have to adhere to existing investors’ restrictions when searching for their target. There are some key risks with this method – if an independent sponsor is unable to find investors for their deal (or takes a long time to raise capital), they could lose out on the acquisition.
Search Fund Investors, Private Equity Fund, and Family Offices
Individual Investors, Private Equity Funds, and Family Offices differ from the examples above because they are unlikely to want to operate an acquired business, instead needing to partner with external operators or senior employees at the acquired business to run the day-to-day. We include them in a single section because they have similar relationships with the small business investments they make, with the key differences coming in the source of their funds. Private Equity Funds are investment vehicles that consist of multiple investors pooling money on behalf of the fund to find attractive investments. Because they operate on behalf of their LPs, private equity funds are limited in the deals they can pursue, depending on their mandates (but can invest large checks into multiple deals). Individual investors, like angel investors in the startup world, are investing their own capital into deals, allowing them to choose operators and companies they find most interesting (though they will often write smaller checks as a result). Finally, Family Offices run private equity firms where the LPs come from one family (or several families). Because of a more limited number of LPs, SMB-focused family offices are able to invest checks into a larger variety of deals, depending on their investment thesis.
Overall, the choice of search strategies a buyer should use really depends on individual goals, preferences, circumstances, access, network, and funding sources. We recommend that aspiring searchers learn as much as they can about the search process and choose a model that best fits their skill sets.