Buyers of small businesses use a wide diversity of strategies to find and close their acquisitions. However, there are two dominant strategies within our space: the Self-Funded and the Traditional Search models. Each provides different routes when it comes to financial outcomes, cap table structuring, and overall control over the process. This post aims to break down these options side-by-side, pointing out their pros and cons to help you figure out which one suits your business goals best.
Financing the Business Search
TL;DR: Self-Funded Searches may attract hands-on individuals comfortable with risk, while Traditional Searches could be better for those seeking larger ventures with shared risks and support from investors.
A Self-Funded search occurs when an entrepreneur endeavors to purchase a single company without the use of institutional capital, instead opting to finance the acquisition with debt and personal funds. As a result, Self-Funded searchers usually buy smaller companies, most often financed through the Small Business Administration’s 7a loan program, which is capped at $5 million. This path offers high upside for the searcher and substantial control, but comes with risks. The SBA loan program requires searchers to provide a personal guarantee. In the event that the company fails, the entrepreneur faces significant loss of personal assets.
Traditional Search is the original model in the industry, popularized at Stanford and with the Stanford Search Fund Study. With this model, an entrepreneur raises institutional capital to purchase a company. Because of this structure, Traditional Searches allow for larger purchases, while simultaneously spreading risk across the entire cap table. While the lack of a personal guarantee means the searcher’s financial risk is lowered, Traditional Search often involves more intricate financial arrangements. While the searcher ends up with a smaller share of ownership and must answer to investors, Traditional Search can lead to substantial profits, especially if the business grows quickly.
However, buyers should be prepared for potentially modest financial gains if the business doesn’t grow.
Equity Distribution and the Balance of Ownership and Control
TL;DR: Self-Funded Searches are best for those who want significant control and are ready to handle higher risk for it, while Traditional Searches appeal to those comfortable with having less control in exchange for shared risk and the backing of investors.
In Self-Funded Searches, buyers usually keep most of the business’s equity. This gives them a lot of control over the business’s direction post-close. But with more control comes more risk, especially if things go wrong.
Traditional Searches typically give searchers a smaller share, with equity spread across the entire investor base. This setup reduces the searcher’s control over day-to-day operations and could even lead to the searcher losing their job if the company underperforms. However, this model offers a meaningful safety net and support system. The searcher’s and investors’ goals are usually aligned through performance-based rewards, pushing the searcher to work towards the business’s success while managing investor relationships.
Income During the Search or Salary Against Equity Stake
TL;DR: Self-Funded Searches suit those good at managing personal finances and willing to invest their own money, while Traditional Searches are ideal for individuals who prioritize financial stability and are prepared to align with investor expectations.
Self-Funded searchers don’t take a salary while they look for a company to buy, instead relying on their own money and careful financial planning during the search process. This path requires a strong ability to handle financial uncertainty and the potential for losses.
In contrast, Traditional Searchers are often paid a salary by their investors for the duration of their search, which brings financial stability while they look for a business to buy. Traditional Search Fund Investors prefer to pay searchers during this period to make sure that the searcher has enough time to find an ideal business. This regular income eases financial worries but usually comes with certain expectations from investors, like hitting specific targets in terms of the acquired company’s size and industry, and less flexibility over where the searcher ends up living.
Battle of the Long-term Strategies: Longevity vs. Defined Exits
TL;DR: Self-Funded Searches lead to long-term, community-focused owners, while Traditional Searches lead to quicker exits with investor guidance.
Self-Funded searchers have the option to grow their business for as long as they want, which is great for those planning to be deeply involved for many years. The “forever hold” model, whereby a searcher buys a company that they don’t plan to sell until retirement, has risen in popularity over the last few years. This approach is best for those who want to be truly integrated into their business and its community.
Traditional Searches often have exit plans set by investors, aiming for a quick return on investment, often in the 5-7 year timeframe. This might speed up financial returns but can also limit how much the business can grow and when it can be sold. However, search fund investors often have different preferences. Searchers looking for security during the search and a longer-term hold should make sure they’re aligned with their Traditional Search fund investors before putting them on the cap table.
Choosing between a Self-Funded or Traditional Search involves considering your financial situation, how much risk you’re willing to take, how much control you want, and what your long-term goals are. Aligning your choice with your personal goals and situation will help set you on the path to a successful business venture.