What is a Search Fund?

By Welch Capital Partners on
By Welch LLP on
May 2, 2024

UNDERSTANDING THE SEARCH FUND MODEL

INTRODUCTION:

In recent years, the search fund model has gained popularity as an alternative investment strategy, particularly among entrepreneurs and investors seeking opportunities in the world of private equity. This unique approach offers aspiring entrepreneurs the chance to acquire and operate an existing business, with the support of investors who provide the necessary capital and guidance. The search fund model has gained traction due to its unique advantages over traditional investment approaches, such as providing entrepreneurs with hands-on operational experience, and offers investors the opportunity to diversify their portfolios and participate in the growth and success of small to medium-sized businesses. In this blog post, we will delve into the search fund model, exploring its key components and the lifecycle of a search fund.

Raise Search Capital (Timeline: 3-6 months): The journey of a search fund typically begins with the entrepreneur raising search capital. This initial phase involves reaching out to potential investors, pitching the concept of the search fund, and securing commitments for capital. In a traditional fund, the entrepreneur raises money from investors to pay their salary for 1-3 years while they search for a business. The timeline for this process can vary but generally falls within the range of 3 to 6 months. During this time, the entrepreneur must effectively communicate their vision, strategy, and qualifications to attract investors who believe in their ability to successfully execute the search fund model. Investors typically look for a well-defined investment thesis, a clear strategy for identifying and acquiring target businesses, and evidence of the entrepreneur's relevant experience and track record.

Below are questions that a potential investor should be asking of the entrepreneur. 

What is your background and track record?

Investors should understand the entrepreneur's educational background, professional experience, and any past entrepreneurial or investment successes. This helps gauge the entrepreneur's capability to identify, acquire, and manage a company successfully.

What is your investment thesis and criteria for target companies?

It's crucial to understand the entrepreneur's strategy for selecting a company to acquire. This includes the industries they are considering, the size of the companies, their financial health, growth potential, and why these criteria are chosen. This insight can help investors determine if they align with the entrepreneur's vision and approach.

How do you plan to manage the acquired company?

Understanding the entrepreneur's plan for managing and growing the acquired company is essential. This includes their role in the company post-acquisition, any team members they plan to bring on board, and their strategy for operational improvements and growth.

What is the structure of the search fund and the terms for investors?

Investors need to know the financial and structural aspects of the search fund, including the compensation for the entrepreneur, the investment horizon, capital requirements, and the expected return on investment. Details about how the fund handles distributions, reporting, and investor involvement should also be discussed.

What are the risks and how will they be mitigated?

Finally, investors should inquire about potential risks involved with the investment, including market risks, management risks, and the specific risks associated with the target company's industry. Understanding how the entrepreneur's plans to mitigate these risks is crucial for assessing the safety and soundness of the investment.

Source and Evaluate Opportunities (Timeline: Up to 2 years): With search capital in hand, the entrepreneur embarks on the task of sourcing and evaluating potential acquisition opportunities. This phase can be the most time-consuming and challenging part of the search fund lifecycle, often spanning up to 2 years or more. The entrepreneur conducts extensive research, network building, and due diligence to identify promising businesses that align with their investment criteria. This involves evaluating factors such as industry dynamics, growth prospects, financial performance, and cultural fit.

Finance and Close Transactions (Timeline: 3-12 months): Once a suitable acquisition target has been identified, the entrepreneur enters into negotiations with the seller to finance and close the transaction. This phase typically involves securing additional financing, structuring the deal, conducting final due diligence, and navigating the legal and regulatory aspects of the transaction. The timeline for completing this phase can range from 3 to 12 months, depending on the complexity of the deal and the parties involved.

Operate the Business (Timeline: 5 years): With the acquisition completed, the entrepreneur transitions into the role of business owner and operator. Over the next several years, the focus shifts to effectively managing and growing the acquired business. This phase involves implementing strategic initiatives, optimizing operations, building and leading teams, and driving profitability and growth. The goal is to create long-term value for both the business and its stakeholders, including investors, employees, and customers. This phase typically spans a period of 5 years or more, during which the entrepreneur is fully immersed in the day-to-day operations of the business.

Sell and Distribute Returns to Investors: The final phase of the search fund lifecycle involves exiting the investment and distributing returns to investors. Once the business has achieved its growth and value creation objectives, the entrepreneur initiates the sale process, either through a strategic sale to a larger company, a private equity, or an initial public offering (IPO). The proceeds from the sale are then distributed to investors, providing them with a return on their initial investment. This phase marks the culmination of the search fund journey, offering investors the opportunity to realize their gains and the entrepreneur the chance to pursue new ventures or opportunities.

If a search fund is not able to close a transaction within the designated timeframe, several potential outcomes may occur, depending on the specific circumstances and agreements in place: 

Extend the Search Period: The investors or backers of the search fund may agree to extend the search period, providing the searchers with additional time to identify and close a suitable transaction. This extension could be agreed upon through negotiation and may involve adjusting the terms or timeline of the search fund.

Pivot or Refocus: If the initial search efforts have been unsuccessful, the searchers may choose to pivot or refocus their search criteria. They could explore alternative industries, geographic regions, or business models to increase the likelihood of finding a suitable acquisition target.

Wind Down the Search Fund: If it becomes evident that closing a transaction is unlikely or not feasible, the searchers may opt to wind down the search fund entirely. This could involve ceasing operations, liquidating any remaining assets, and distributing proceeds to investors.

Continue the Search: In some cases, searchers may continue their efforts beyond the initial timeframe, either independently or with the support of investors who are willing to provide ongoing funding. They may pursue additional fundraising efforts or explore other avenues to identify potential acquisition targets.

The failure of a search fund can also lead to financial losses for investors, opportunity costs for the entrepreneur, and a potential impact on the reputations, affecting future fundraising and investment opportunities.

CONCLUSION:

The search fund model offers a unique and compelling path for entrepreneurs and investors alike. By providing entrepreneurs with access to capital and resources, along with the autonomy to acquire and operate a business, search funds enable individuals to pursue their entrepreneurial aspirations while delivering attractive returns to investors. Understanding the lifecycle of a search fund—from raising search capital to exiting the investment—can help entrepreneurs and investors navigate this dynamic and rewarding investment strategy effectively.

Inevitably, challenges may arise, and not every search fund will successfully close a transaction within the designated timeframe. However, the response to such challenges is crucial, and it often involves effective communication, flexibility, and adaptability. Whether it's extending the search period, returning capital to investors, pivoting the search criteria, or continuing the search with renewed vigor, searchers and investors must collaborate to determine the best course of action. Ultimately, the journey of a search fund is marked by its resilience, determination, and commitment to creating value for all stakeholders involved.

Please contact draj@welchcapitalpartners.com to learn more about search funds.

UNDERSTANDING THE SEARCH FUND MODEL

INTRODUCTION:

In recent years, the search fund model has gained popularity as an alternative investment strategy, particularly among entrepreneurs and investors seeking opportunities in the world of private equity. This unique approach offers aspiring entrepreneurs the chance to acquire and operate an existing business, with the support of investors who provide the necessary capital and guidance. The search fund model has gained traction due to its unique advantages over traditional investment approaches, such as providing entrepreneurs with hands-on operational experience, and offers investors the opportunity to diversify their portfolios and participate in the growth and success of small to medium-sized businesses. In this blog post, we will delve into the search fund model, exploring its key components and the lifecycle of a search fund.

Raise Search Capital (Timeline: 3-6 months): The journey of a search fund typically begins with the entrepreneur raising search capital. This initial phase involves reaching out to potential investors, pitching the concept of the search fund, and securing commitments for capital. In a traditional fund, the entrepreneur raises money from investors to pay their salary for 1-3 years while they search for a business. The timeline for this process can vary but generally falls within the range of 3 to 6 months. During this time, the entrepreneur must effectively communicate their vision, strategy, and qualifications to attract investors who believe in their ability to successfully execute the search fund model. Investors typically look for a well-defined investment thesis, a clear strategy for identifying and acquiring target businesses, and evidence of the entrepreneur's relevant experience and track record.

Below are questions that a potential investor should be asking of the entrepreneur. 

What is your background and track record?

Investors should understand the entrepreneur's educational background, professional experience, and any past entrepreneurial or investment successes. This helps gauge the entrepreneur's capability to identify, acquire, and manage a company successfully.

What is your investment thesis and criteria for target companies?

It's crucial to understand the entrepreneur's strategy for selecting a company to acquire. This includes the industries they are considering, the size of the companies, their financial health, growth potential, and why these criteria are chosen. This insight can help investors determine if they align with the entrepreneur's vision and approach.

How do you plan to manage the acquired company?

Understanding the entrepreneur's plan for managing and growing the acquired company is essential. This includes their role in the company post-acquisition, any team members they plan to bring on board, and their strategy for operational improvements and growth.

What is the structure of the search fund and the terms for investors?

Investors need to know the financial and structural aspects of the search fund, including the compensation for the entrepreneur, the investment horizon, capital requirements, and the expected return on investment. Details about how the fund handles distributions, reporting, and investor involvement should also be discussed.

What are the risks and how will they be mitigated?

Finally, investors should inquire about potential risks involved with the investment, including market risks, management risks, and the specific risks associated with the target company's industry. Understanding how the entrepreneur's plans to mitigate these risks is crucial for assessing the safety and soundness of the investment.

Source and Evaluate Opportunities (Timeline: Up to 2 years): With search capital in hand, the entrepreneur embarks on the task of sourcing and evaluating potential acquisition opportunities. This phase can be the most time-consuming and challenging part of the search fund lifecycle, often spanning up to 2 years or more. The entrepreneur conducts extensive research, network building, and due diligence to identify promising businesses that align with their investment criteria. This involves evaluating factors such as industry dynamics, growth prospects, financial performance, and cultural fit.

Finance and Close Transactions (Timeline: 3-12 months): Once a suitable acquisition target has been identified, the entrepreneur enters into negotiations with the seller to finance and close the transaction. This phase typically involves securing additional financing, structuring the deal, conducting final due diligence, and navigating the legal and regulatory aspects of the transaction. The timeline for completing this phase can range from 3 to 12 months, depending on the complexity of the deal and the parties involved.

Operate the Business (Timeline: 5 years): With the acquisition completed, the entrepreneur transitions into the role of business owner and operator. Over the next several years, the focus shifts to effectively managing and growing the acquired business. This phase involves implementing strategic initiatives, optimizing operations, building and leading teams, and driving profitability and growth. The goal is to create long-term value for both the business and its stakeholders, including investors, employees, and customers. This phase typically spans a period of 5 years or more, during which the entrepreneur is fully immersed in the day-to-day operations of the business.

Sell and Distribute Returns to Investors: The final phase of the search fund lifecycle involves exiting the investment and distributing returns to investors. Once the business has achieved its growth and value creation objectives, the entrepreneur initiates the sale process, either through a strategic sale to a larger company, a private equity, or an initial public offering (IPO). The proceeds from the sale are then distributed to investors, providing them with a return on their initial investment. This phase marks the culmination of the search fund journey, offering investors the opportunity to realize their gains and the entrepreneur the chance to pursue new ventures or opportunities.

If a search fund is not able to close a transaction within the designated timeframe, several potential outcomes may occur, depending on the specific circumstances and agreements in place: 

Extend the Search Period: The investors or backers of the search fund may agree to extend the search period, providing the searchers with additional time to identify and close a suitable transaction. This extension could be agreed upon through negotiation and may involve adjusting the terms or timeline of the search fund.

Pivot or Refocus: If the initial search efforts have been unsuccessful, the searchers may choose to pivot or refocus their search criteria. They could explore alternative industries, geographic regions, or business models to increase the likelihood of finding a suitable acquisition target.

Wind Down the Search Fund: If it becomes evident that closing a transaction is unlikely or not feasible, the searchers may opt to wind down the search fund entirely. This could involve ceasing operations, liquidating any remaining assets, and distributing proceeds to investors.

Continue the Search: In some cases, searchers may continue their efforts beyond the initial timeframe, either independently or with the support of investors who are willing to provide ongoing funding. They may pursue additional fundraising efforts or explore other avenues to identify potential acquisition targets.

The failure of a search fund can also lead to financial losses for investors, opportunity costs for the entrepreneur, and a potential impact on the reputations, affecting future fundraising and investment opportunities.

CONCLUSION:

The search fund model offers a unique and compelling path for entrepreneurs and investors alike. By providing entrepreneurs with access to capital and resources, along with the autonomy to acquire and operate a business, search funds enable individuals to pursue their entrepreneurial aspirations while delivering attractive returns to investors. Understanding the lifecycle of a search fund—from raising search capital to exiting the investment—can help entrepreneurs and investors navigate this dynamic and rewarding investment strategy effectively.

Inevitably, challenges may arise, and not every search fund will successfully close a transaction within the designated timeframe. However, the response to such challenges is crucial, and it often involves effective communication, flexibility, and adaptability. Whether it's extending the search period, returning capital to investors, pivoting the search criteria, or continuing the search with renewed vigor, searchers and investors must collaborate to determine the best course of action. Ultimately, the journey of a search fund is marked by its resilience, determination, and commitment to creating value for all stakeholders involved.

Please contact draj@welchcapitalpartners.com to learn more about search funds.

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