Go Buy Yourself Something Nice: A Brief Intro to Search Funds
What if I told you there was a group of investors out there that wanted to invest in you as an entrepreneur? If I told you that these investors would bankroll your search to find a great company? If I told you that they would acquire the company and install you as CEO with a 30% equity stake?
Does that sound like something you might be interested in?
It sounded improbable to me at first, but this model — known as a “search fund” — is very much a real proposition for a growing number of newly minted MBA’s across the country. According to a study on search funds published biannually by Stanford’s Center for Entrepreneurial Studies (CES), a search fund is a “pool of capital raised to financially support the efforts of an entrepreneur, or a pair of entrepreneurs, to locate and acquire a privately-held company for the purpose of operating and growing it.”
The first known search fund was raised in 1984, and since then there have been over 150 of these types of funds. A recent MBA graduate from Michigan’s own Ross School Business, Ned Tomasevic, began raising his fund after finishing his MBA last spring. By the end of the summer he had finished raising his search capital. On a visit to Ross back in November, Ned spoke to aspiring searchers about his experiences.
Interest in search funds has been growing among Ross students. The school’s Entrepreneur and Venture Club (EVC) hosted two talks on search funds in November, and Ned’s fund- Toma Capital, LLC has hired two interns from the business school to help him evaluate businesses for potential acquisition. Steve Johnston, a second year MBA at Ross explained, “the search fund is a great alternative entrepreneurial path for folks that want to operate and grow a business…what business school grad doesn’t want to be a CEO at age 30?”
Of the 26 new search funds examined in the 2011 CES study, the median amount of initial search capital raised was around $450,000. Once the initial fund has been raised, the searcher(s) begin the arduous process of finding and evaluating businesses that might potentially be sold. Though search funds have acquired a wide range of businesses, searchers look for certain characteristics: simple operations, a growing industry, healthy and sustainable margins, recurring revenue models, and a history of cash flow generation.
When a suitable business is found, it is generally acquired with some combination of bank debt and additional capital from the search fund investors. A majority of search fund acquisitions range from $4 million to $12 million (the median acquisition in the 2011 study was for $7.9 million), but on a rare occasion, the acquisition is much larger. One acquisition in the 2011 study was for a whopping $71 million.
Search funds are still relatively uncommon, and the investor pool is extremely homogenous. For these reasons, these deals tend to have very similar structures. Learning about search funds left me wondering what kind of roles an attorney can play throughout the fund’s life cycle.
It seems to me that a good attorney- one that specialized in the search fund model can add value at every step of the process. At the earliest stage the attorney can help properly form the fund and negotiate terms with the fund’s initial investors. During the search, an attorney can be instrumental in the diligence process and in negotiating terms with the target company’s current owners. And, of course the acquisition will require a great deal of specialized legal work. The fund’s attorney will again be instrumental in the eventual event of a successful exit.
Is the search fund proposition just as dreamy for an attorney as it is for an aspiring young CEO? Could be.