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5 Lessons from a Failed Search Fund

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When a new venture fails, it’s always worthwhile running a post-mortem to look for lessons. This equally applies to financial ventures — in this case, a search fund.

Jim (not his real name), a US military veteran working in the financial services industry, got interested in search funds after watching a buddy from the military successfully take over a small business using an SBA loan and some additional investors. It got him thinking — could he and his friends help other veterans find, buy, and run healthy small businesses?

They started off with high hopes. Investors were interested in the concept and business owners were keen on the idea of selling to a veteran. But difficulties ensued. Deal flow, or rather the right kind of deal flow, was challenging. They discovered that the desire to sell to a veteran did not ultimately trump better price and terms from other suitors.

After a long hunt, Jim  competed hard for two deals, lost both, and ultimately decided to throw in the towel.

Here are Jim’s five key takeaways:

1. Do it full time or not at all:

You can’t do a search fund on the side. It is too hard to find the right kind of business, and you simply won’t be able to compete with people doing it full time.

2. Don’t rely on broker deals:

If you’re going to find a deal, it’s not going to come from mass-marketed broker deals. In Jim’s experience, those brokers have upwards of 30 groups to whom they give “first looks” and so the best deals will already be picked off. But even the quality deals that get widely marketed by these brokers get bid up too high for a search fund to compete.

3. Be realistic about imperfections:

Jim began by reading all the MBA materials on what made a good search fund purchase. In the end, this was too restrictive and too idealized a definition to be viable in the real world. You are going to struggle to find high EBITDA margins, growth potential, recurring revenue, nice market size, limited competition, and a sub-$5M price tag.  You need to compromise somewhere and decide which imperfections you are willing to live with.

4. Keep a broad geographic filter

When Jim started, he tried to limit his search within his home state. In retrospect, he wished he had been location-agnostic from the start. The volume of interesting deal flow in his backyard was too small.

5. Talk to people who have been through it before you start

You want to go into a search fund with your eyes open to the downsides. People like to focus on the upsides, but there are a lot of risks, not least being that the real work begins after the deal is done. Jim also pointed out that the economics aren’t actually that great for the searcher, at least for their first deal. “Once you start taking other people’s money,” Jim said, “They’re gonna get theirs and then some.”

Jim still has many friends running search funds, but he has seen many of these searches take up to two years, and even then only a third successfully close a deal. Ultimately, he acknowledged that some of the difficulty in doing a search fund comes from the narrow definition of what makes a good search fund acquisition. “If we were open to buying small but well-run landscaping or oil change shops, we would have had a lot more opportunities,” he said.

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