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Search Funds and Entrepreneurship Through Acquisition

Today, as part of our efforts to educate about successful entrepreneurship strategies, we will deep dive into another way for underrepresented entrepreneurs to enter the field and create wealth for themselves.

Traditionally when people think about entrepreneurship, they think of someone who builds a business from the ground up. However, another very lucrative path to entrepreneurship exists! Using the Search Fund model, aspiring entrepreneurs can fulfill their dreams of becoming business owners through acquisition.

History of Search Funds

The Search Fund model began in 1984 by the entrepreneur and academic, Irving Grousbeck. Search Funds allow aspiring entrepreneurs to raise capital for the purpose of identifying, acquiring, operating, growing, and eventually selling a company.

Types of Search Funds

Generally, there are 3 types of Search Funds:

1. Sponsored (traditional) – capital is raised from investors to pay the aspiring entrepreneur a modest salary for the duration of the company identification and acquisition search process. Once a target company is identified, the investors are then able to exercise their options to purchase equity in the company.

2. Self-funded – unlike a traditional search fund, the entrepreneur does not raise capital from investors for the duration of the acquisition search process. Instead, once the target company is identified, the entrepreneur approaches investors for the capital needed to purchase equity in the company.

3. Accelerators – structured programs that provide guidance and resources to Searchers throughout the acquisition process.

How does a Search Fund work?

The Search Fund model typically occurs within 4 stages:

1. The capital raising stage

2. The search and acquisition stage

3. The operational stage

4. The exit

When following the sponsored (traditional) Search Fund model, once an aspiring entrepreneur determines that entrepreneurship through acquisition is the right path for them, they need to raise initial capital from investors. To accomplish this, a private placement memorandum (PPM) is prepared and pitched to investors.

Typically, a Searcher will seek to sell 12 – 16 “ownership units” of the Search Fund at an average price of $35 - $50 thousand per unit. It is important to ensure that the right investor mix is selected. For instance, prioritization criteria may include factors such as subject matter or industry expertise, geographic location, network, etc.

When investing in Search Funds, investors budget 2 years for the Searcher to identify, conduct due diligence, and acquire the target company. According to a 2016 study performed by the Stanford Graduate School of Business, the median search process is ~19 months. If at the end of the 2 years no acquisition has occurred, the Search Fund is dissolved, and the investors do not make any capital contributions.

Upon successfully acquiring a target company, the aspiring entrepreneur must now focus on operating and growing the business. Examples of areas of growth may include revenue, margin expansion, new product development, international expansion, and many more!

After operating and growing the business, it is then time to exit and return capital to investors. This can take the form of a sale to a private equity firm, to a strategic corporate buyer, or even to public market investors, through an IPO.

What makes a company a good acquisition target?

The typical Search Fund target company usually has a $5 -$30 million valuation requiring $2 -$10 million in capital from investors. This is based on $1 -$5 million of EBITDA and $2 -$30 million of revenue. Ideally, the company will operate within a fragmented industry, have a sustainable business model with a track record of positive cash flows, and untapped long-term growth opportunities. Most importantly, however, the current owner must be willing to sell their business!

Reginald Lewis is a famous example of a member of the Black community who created wealth for himself through acquisition. In Canada BETA-i is working to expand entrepreneurship through acquisition for Black community. It is the first Canadian Black-focused incubator in the search fund world.

Thinking through your strategy from the outset can bring clarity about the funding route best suited to your business model. While we serve companies that are VC backable,

underestimated and historically underrepresented founders should be aware of other entrepreneurial pathways that may align with their values and mission better.

Interested in learning more? Here are some resources:

Thanks to Noah Figdor for writing this piece.


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