Last week I had a nice conversation with a mid-career person looking to buy a business. He was contemplating using the “search fund” model to find and buy a business. As a brief background, a search fund is a model where an entrepreneur raises a pool of capital from investors to cover expenses during their search for an attractive business to buy. Once a business is identified, the investors have an option, not a commitment, to invest and they get some additional preferences for having funded the search. For business owners looking to sell, search funds may be an option for you, particularly if you want to exit the business and bring in a new management team. Most of the time, the entrepreneurs running the search want to manage the business post acquisition. When I bought the National Holistic Institute coming out of business school, I did not use a search fund — I did what is called an “unfunded search” or basically I paid for the search expenses myself. I also had a business school friend and classmate use the unfunded search model.
Funded Business Search Pros:
Our conversations were about whether to do the “funded search” or “unfunded search”. Here are some of the observations that we discussed. First, the pros of a search fund…
- Money to pay the bills while searching. For some, this is essential.
- Well-established group of investors in search funds that have experience and success with the model. You will not have to reinvent the wheel.
- Experience, advice, and guidance. This is key. It isn’t easy to find a business, separate the good from the bad, strike a fair deal, not miss anything in diligence, and get it closed. Experience and guidance at key moments helps a lot. The search fund investors that I know best are the Search Fund Partners in Palo Alto. They are quality guys, they are wise investors, and they would be a great help to anyone searching for a business to buy.
- More certainty of closing because financing is more firm. Because the investors are already lined up, it is usually much easier to close a deal once you have found the business. In an unfunded search, it may be a scramble to line-up the financing although good deals have a way of finding capital and getting done.
Funded Business Search Cons:
- Can limit the universe of potential targets. Because search fund investors need businesses of a certain size or growth rate, it may limit the businesses you may target somewhat.
- Will need to sell the business. Search fund investors will expect a return of their capital in 5-10 years. If you want to own your business for a longer term time horizon, you may be somewhat misaligned with search fund investors. Sometimes, there are huge success stories of companies found through a search fund, such as Assurian, that have been successful recapitalizing the business several times to return capital to investors.
- May not be able to utilize some funding sources, like SBA loans. This may not matter to you, but having investors will mean certain types of financing will not be available such as SBA loans that require personal guarantees from most owners which search fund investors will not be willing to do.
- Financial model works best if you can fund it yourself. Without investors, your financial returns for yourself will likely be better has researched by Richard Ruback of the Harvard Business School in his research on the market for smaller firms.
Most often, people will choose a funded search because the pros outweigh the cons. That is probably a good choice. If you do have the option to fund the search yourself, it is worth exploring as it worked for me and a couple of other people that I know.