About a year ago I stumbled upon what seemed like a strange niche corner of the small business world - searchers.
At that point I had been the Executive Director of an SBA lender for a decade and had never heard of a “searcher” despite the fact that we had closed many, many small business acquisition loans. Through spending some time on Searchfunder, and SMB Twitter it started to click for me and I started to really dig into how this all worked.
I have a background in accounting, am the Co-Founder of ProjectionHub, and spent a decade in SBA lending and it still took me a while and multiple different websites and podcasts and Twitter of course to kind of put it all together. I figured I am not alone and that there are others just learning about search funds for the first time, so I wanted to put together what I hope will be a pretty comprehensive introduction to search funds. Below is the outline of what I plan to cover.
So much to cover, let’s dive in!
A search fund is an investment vehicle that allows an entrepreneur to raise funding from investors in order to acquire a company according to Wikipedia. The entrepreneur, also known as the “searcher”, will take a leadership role at the acquired company and operate the day-to-day of the business.
When I first heard about this I thought people were just making up names for what sounded like finding investors to help you acquire a company. Why all of the strange terms like search fund and searcher?
Well there are some aspects that make a search fund more than just finding a couple of investors to help you come up with the capital to acquire a company. The primary thing, from my perspective, that makes a search fund unique is that the searcher will actually find investors to put capital into the fund in order to pay for a reasonable salary for the searcher as well as search costs like due diligence and travel expenses for potential acquisitions.
Basically the search fund concept acknowledges that it takes time to find a good business to acquire and time to close the deal. There are investors that might like to acquire a business, but they don’t have the time to source the deal, complete due diligence, and close the deal, so they take their capital and invest in a search fund and a searcher that can do that work.
A search fund also solves a couple of problems for the searcher:
There are two distinct phases of a search fund:
After the acquisition the search fund investors would each own a portion of the company, but the searcher would also retain a percentage of the company. We will get into more of those details later.
The search fund concept was originated by Stanford Professor H. Irving Grousback in the mid 1980s. It seems that the basic idea was that recent MBA graduates from the countries top MBA programs might have the knowledge, desire and leadership skills to be able to lead a company right out of school, but they might not have the capital to be able to buy a business yet. Search funds became an option for elite MBA students to pursue instead of starting their own company or going to work in management at a larger firm.
According to True North Search:
“Entrepreneurship Through Acquisition is a well-proven model, where an aspiring entrepreneur searches for, acquires, operates and grows an established small business. The acquisition capital is provided by third party investors, while the new entrepreneur operator retains a significant equity share in the business.”
Not everyone wants to start a business from scratch, not everyone has the mindset necessary to take a business from 0 to 1, so entrepreneurship through acquisition (ETA) is another approach to business ownership.
There are countless examples of business owners buying an existing business utilizing an SBA loan, seller financing and other creative financing options where the searcher can retain a majority of the ownership of the business, so why would you want to use the search fund option? From my perspective there are few reasons why starting a search fund makes sense:
So far I have been describing what is typically called the traditional search fund model where investors put in capital to fund the salary and search expenses of the searcher, but you could still operate a search fund structure where you have a group of investors that help you acquire the company once you get to that point.
A self funded search is when a searcher will fund the search period from their own savings or outside income rather than raising funding from search fund investors.
The reason you might want to self fund your search is because you would end up with a higher percentage of ownership in the company post acquisition if your investors don’t have to take the risk to put in money early to fund the search process.
There is a surprising amount of search volume on Google for search phrases like “how to buy a business with no money” which frankly sounds like a pretty bad idea in most cases. If you truly have no savings, you probably need a job, not to buy a business. But if what you are looking for is a way to acquire a business with little to no personal cash investment, then a search fund is an option. If you are the right operator, you might be able to convince a group of investors to join your search fund and provide you with all of the financial backing you need to buy a business.
Use our Acquisition Projection Template to Analyze Potential Acquisitions!
Based on these assumptions our forecasted IRR is 53%.
Now if you don’t have a cash flow forecast already in place, you can use our Acquisition Financial Projection Template to create a pro forma with forecasted cash flow. The model will allow you to enter your historical financials and then implement projected increases or decreases for your revenue and expenses. It will also allow you to enter in unique financing details of the acquisition including investment, SBA loans, and seller notes in order to project future cash flows. The acquisition template is industry agnostic making it perfect for searchers to utilize to create pro formas for multiple potential deals.
A search fund can be broken down into 4 stages with the following average timelines according to the 2022 Stanford study:
The assumption going into a search fund is that eventually you will sell the business in order to provide liquidity and investor returns to your initial investors.
Again, selling the business is typically the long term plan for a search fund. That provides a liquidity event for the searcher as well as the initial investors, but when should you sell the business? The answer is probably when you can maximize your returns for your investors which is another way to say who knows exactly when that will be. But to give you some idea, according to the 2022 Stanford study that we keep referencing, out of 131 exited companies the average time to exit was between 5 and 7 years.
Ok that is it! I hope you found this helpful as a comprehensive introduction to search funds. As you begin your search process and need to model potential acquisitions, keep ProjectionHub in mind, we would be more than happy to help! Best of luck!
Adam is the Co-founder of ProjectionHub which helps entrepreneurs create financial projections for potential investors, lenders and internal business planning. Since 2012, over 50,000 entrepreneurs from around the world have used ProjectionHub to help create financial projections.
