How search funds have adapted for today's market

Jason Salisbury

Guest Columnist

February 6, 2024

The landscape of business acquisition is ever-evolving.

Among the traditional players like corporate buyers and private equity firms, there’s another breed of business hunter: search funds.

These often financially sophisticated entrepreneurs are seeking businesses with big opportunities.

For sellers, they offer an alternative path to exit, with distinct risks and benefits.

The traditional B-school model
The search fund concept originated at the Stanford Graduate School of Business in the 1980s.

The idea was that ambitious MBAs could raise a small pool of capital (typically from wealthy alumni) to sustain themselves for a couple of years while they searched for a business to acquire.

When the search funder found the right opportunity, they’d leverage those same investors to fund the deal.

The “searcher” would then take over as CEO, growing the business and providing a return to the investors over time.

It can be a terrific opportunity for a young professional who is prepared to relocate and make bold moves.

After several years, if all goes well, they can earn themselves some stellar business credentials and a significant amount of equity.

Varied and institutionalized
Today, the search fund landscape has grown more robust and varied.

The number of active search funds has ballooned — thanks in part to formalized programs at several top MBA schools.

Kellogg and Harvard were among the first to follow Stanford’s model, and others followed suit.

But search funders now span demographics.

While many are still hungry 20-somethings fresh out of grad school, it’s increasingly common to see industry veterans in their 40s or 50s raise search capital to transition into business ownership.

There’s even growing institutional support.

A new crop of private equity firms are backing seasoned operators they believe can buy and scale a small business while the firms support the searchers by filling the capital raising and other back-office functions of the search.

When search fund buyers make sense for sellers
Search fund buyers get a bad rap in some circles, but they can be ideal acquirers for the right business.

Owners may find search funds appealing because they’re led by a passionate leader who will be actively involved in the company’s future.

That can be more attractive than selling to another corporation, which may relocate, rename or make other significant changes to the business.

It can also be preferable over traditional private equity, which typically requires the seller to stay on for a multi-year transition.

Moreover, search fund buyers may have more stick-to-itiveness than your average private equity firm.

If things go sideways, private equity may be more likely to close things down and liquidate assets than an individual who has gone all-in.

The searcher has more at stake in terms of reputation and future prospects than a firm that can cut their losses and try again.

When sellers make sense for a search fund
What makes a business a good fit for a search fund?

Typically, these companies are profitable but too small to generate much interest from private equity, say under $5 million EBITDA.

A searcher is looking for stable revenue, reducing risk for a first-time operator.

But they’re also looking for a clear growth thesis, such as new sales channels, automation, related service lines, etc.

Red flags to watch out for
Not all search funds are created equal.

There’s a lot of hype around the search fund model right now — search TikTok for “search funds” and you’ll see what I mean.

That can create a lot of noise and distraction.

A business we’re marketing recently gained more than 100 inquiries from search funders.

A proven tech company with recurring revenue and its owners have mostly stepped back from the business — is a ripe opportunity for someone with energy and drive.

However, only a fraction of those would-be buyers are ready to complete a deal.

Watch out for the searcher who is overly confident about running your business, despite no relevant experience.

And beware of anyone who leads with a valuation offer well above market rates.

Working with a search fund may mean you and your advisors essentially have to “sell” the deal twice — once to the search funder and then again to their investor group.

Lions, zebras and balance sheets
Forty-odd years ago, a search fund was essentially a “hunting license” for aspiring entrepreneurs.

But today, search fund buyers run the gamut.

If you have a solid business with untapped expansion potential, an ambitious search funder with the right experience and backers can be a compelling option.