Why Search Funds Might Make Sense

January 24, 2013 · 3 min read

Some Stanford lecturers and alumni are involved in the business of search fund, but this is one type of investment vehicle that is often not well understood by people from outside. The model makes sense to the three parties involved in the following ways ...

Confession of a Stanford Sloan Fellow Series EP41

For the searchers (MBAs in pair, who go raising capital to fund the search, identify an acquisition target company, raise more capital to buy it, run it for several years, and sell it for profit at the right EBIDTA),

This model is almost exclusively for MBAs (mostly young) with little to no operating/management experience but have some entrepreneurial spirit to be a change agent and live their lives on their own terms.
It fits with newly minted MBAs' desire of running businesses, improving operation and managing processes.
Many MBAs (especially those with consulting or banking background) have no particular desire for product creation/development, nor strong passion for any particular domains, but want to run a business by applying business school tactics and skills. Search fund's model suits such desire.
It provides to the searchers the opportunity to become CEO of a small to medium-sized company (right away after the search is completed and the deal is closed), which is not available to most MBA graduates.
The searchers have the luxury of learning the business at reasonable pace and groom themselves into effective CEOs because search fund targets are usually cash flow positive business with stable business models.
The searchers don't have to deal with the nuances faced by the CEO of a typical startup, like handling all the back room matters.
There is a possibility that it could be relatively easy to turn around a small-sized traditional type of business that doesn't typically embrace modern management practice such as regular team meetings or neat financial analysis from Excel. There might be many low-hanging fruits there.

For the investors (individuals who give capital to the searchers)

Lower risk (lower return as well) because the target companies already have EBIDTA and a stable operating structure and environment.
Lower entry of investment compared to VC and PE funds.
Contrarian play because most of the target companies are in traditional, less sexy industries (but with potential to unlock value from simple process improvement) that are often overlooked by the VC/PE firms.
Lower risk from more flexibility in capital commitment due to the two-staged funding process and the usual right-of-the-first-refusal clause.
Ability to get much more involvement and utilize his/her own domain expertise, unlike being a LP in a typical VC/PE fund.
Better access to the invested target companies because GP = Management team, which provides a higher level of comfort and lowers the perceived risk.

For the sellers (current owners of the target company who sell the company to the search fund)

Search funds might be the only buyers available as their companies are usually fairly small, under the radar screen of the big VC/PE firms.
Suits the needs for the owners/founders who want to retire but want to make sure the business is in good hands as search fund GPs are much more committed than typical VC professionals, who are pure financial investors.