Why the Traditional Search Fund Model is Changing

Billy Fink Axial | March 19, 2014

Let’s face it, search funds have not always had the best reputation. But that may be changing.

In recent years, the traditional search fund model has begun to evolve to address some of the common concerns — namely around lack of experience and lack of committed capital.

To learn more about these developments, we spoke with Professors Yudkoff and Ruback of Harvard Business School and Kousha Bautista-Saeyan of Long Trail Leadership.

A Growing Number of Searchers

Although the search fund community is still relatively small, it has been growing in popularity. “An increasing number of talented, young businesspeople are being drawn to the idea of acquiring smaller firms and then running them as CEO,” explained Professor Royce Yudkoff of Harvard Business School. “Here at HBS, the number of people taking courses on this subject is up 8x over the past 3 years.”

General interest in the strategy has grown in response to many baby boomers reaching the retirement age. “Overall, there is greater awareness among young entrepreneurs of the need for older entrepreneurs to sell their business,” explained Professor Yudkoff. “These exiting business owners need an investor that can both help them take chips off the table and take over managing the business.” Many young businesspeople are recognizing this fundamental demographic shift, and are trying to capitalize on the opportunity.

One such searcher is Kousha Bautista-Saeyan of Long Trail Leadership. “I was particularly drawn to the search fund model because it sat between the two poles of corporate life and startup life,” he explained. “While I knew I wanted to run a business, I didn’t feel comfortable shouldering the risk of creating a new company. The search fund model is less risky, but still exciting.”

And a Growing Diversity

While these searchers are similar in their desire to run a business, they are quite diverse in their skill sets and experiences. “I am impressed by the breadth of successful patterns in our searchers,” commented Professor Richard Ruback, also of Harvard Business School. “It is not the case that any one set of experiences makes for a successful searcher — there is no one size fits all. Our searchers are usually in their 30s and have had substantial work experience, on which they are able to build in a very productive way.”

Instead of a specific professional track, the most successful searchers tend to have the same qualities that make for any successful entrepreneur. “Tenacity, energy, and interpersonal competence are three qualities that help make for a successful searcher,” Professor Yudkoff commented. “The search fund process is endless work and one needs to be able to overcome the challenges.”

New Strategies Developing

As young entrepreneurs adopt the search fund model in greater numbers, they are also seeking to change it. “There has been increasing diversification of the search fund model recently,” explained Bautista-Saeyan. “People are spotting inefficiencies in traditional models and are shifting appropriately.”

The traditional model focuses on the ‘search fund mafia’, “the group of 10-20 investors that have traditionally backed searchers,” explained Bautista-Saeyan. “Generally, if you can convince them, they will each invest a small amount in your search process and reserve the opportunity to invest in the business.” But, this model is falling out of favor for many searchers due to its relative inefficiency and lack of dedicated partnership from any one of the mafiosos.

“One of the most popular alternative models is many searchers are now seeking one or two partners that will support them with committed capital and advice, instead of going to 20 different individuals. It is a real partnership,” said Bautista-Saeyan.

Besides addressing the logistical challenges of the traditional model, this new model helps to mitigate some concerns expressed by intermediaries and business owners — namely inexperience and lack of committed capital. “The new model is appealing to searchers and business owners alike since it brings committed capital, energetic youth, and ‘gray hair’ experience to the table,” explained Bautista-Saeyan. “The combination of young searchers to run the business combined with more senior partners offers an appealing partnership.”

While many of the new searchers have adopted this partnership model, it is not easily reproducible. “While more appealing, this is a much more difficult model to replicate since you have to find one or two HNWIs that trust and believe in the searcher,” said Bautista-Saeyan. “The cost to each investor is significantly higher, since the risk and capital are not diversified, but the likelihood of success is higher and they are more willing to offer advice.”

When and Why to Include a Searcher on a Buyer List

The growing popularity and changing models has caused many intermediaries and business owners to warm up to the searcher model.

“Merger advisors are becoming more aware of the value of a searcher and look at this trend as helpful to solving some of their problems,” explained Professor Yudkoff. “When a business broker has a seller who wanted to retire from a smaller firm and sell it, they knew they would have a problem [drawing the interest of] private equity — because of the size of the business and owner wanting to leave. Searchers give more options to business brokers than they had before.”

Although the perception from intermediaries is improving, not all businesses are meant for a searcher. As Professor Ruback explained, “very large and/or overly complex businesses are not appropriate for searchers. It is hard to imagine the searcher stepping in, for example, to a business with $100 million in revenue and being prepared to take on that management challenge. There are certain challenges [associated with] that type of business that pure energy and tenacity cannot overcome.”

However, if the business is “within the scope of an energetic, well-trained 30 year old with valuable experience” or is “in the range of $0.5 – $3 million in EBITDA,” the business owner should seriously consider a searcher.

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