Is a Search Fund the Right Partner for Your Business?

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By Tim Meaney,
Vice President

Sellers today have many options when it comes to finding the right type of partner to acquire or invest capital in their company. The number of strategic buyers seeking acquisitions, traditional private equity funds, family offices, and independent financial sponsors have increased the possibilities available to an owner wishing to transition a middle market business. But a less well-known buyer type – Search Funds – might be the best fit for certain sellers and their employees.

Owner Situations Favoring a Search Fund:

  • Owner wants to retire or cut back after the transaction
  • No succession CEO in the company/family
  • Required industry-specific knowledge can be quickly obtained
  • Company has low business risk

Conceived in the 1980’s and becoming increasingly common over the past decade, a search fund is a unique investment vehicle through which a group of investors, often with business backgrounds, financially support an entrepreneur’s efforts to search for, acquire, manage, and grow a privately held company.

The individual (or principal) of a search fund will typically seek to identify and acquire a single company in which he or she will assume an active day-to-day leadership role as CEO or President, once the acquisition is completed. Some sellers might prefer selling to an individual willing to take over their company, rather than selling to a competitor who might adversely impact employees or company culture. Search funds, by their nature, can help in instances where a lack of management depth might deter buyers who require experienced day-to-day management teams in place.

Some common characteristics of search funds include:

  • Most search funds have a longer-term outlook than private equity funds that have shorter term requirements to return capital to fund investors. Search fund principals often choose to refinance out their initial equity investors and then stay with the company as a sole owner.
  • Search funds typically prefer to target businesses or industries which seem insulated from technological change, have straightforward business models, or operate in fragmented geographical or product markets.
  • The purchase prices of the company acquired by a search fund is typically from one or two million to $25 million.
  • Search fund principals may come from diverse professional backgrounds including operations, sales, investment banking/finance, private equity, or general management careers.
  • In a search fund, investors typically invest money in two stages: (1) to fund the search (i.e. to pay the entrepreneur a modest salary and cover administrative and deal-related expenses over a two- or three-year period while he or she searches for an acquisition) and (2) to fund the acquisition of a given company.
  • Investors who contribute the initial search capital (often five to 20 institutional or wealthy individuals) typically have the right, but not obligation, to invest pro-rata in the equity required to consummate the acquisition. So, the certainty of close may be lower and the process slower than with a private equity or strategic buyer which has its equity in hand and more deal experience.
  • Search funds may not offer the highest price and best terms in an auction process unless the company fits the search fund profile.

While search funds can offer certain sellers a good option in the sale process, finding and selecting the best groups to consider – and ultimately transact with – requires guidance from an M&A advisor. There are roughly 300 to 400 search funds in the United States. In our experience, it’s the search fund principal’s professional background, search history, investor base, lender support, and character that will ultimately determine the outcome of a deal.

The M&A market remains strong for a wide range of sellers. But like with most important decisions and processes, having another option to consider is a good thing.

© Copyrighted by EdgePoint.  Tim Meaney can be reached at 216-342-5857, by email at tmeaney@edgepoint.com or on the web at www.edgepoint.com

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