Though search funds still make up a relatively small percentage of lower middle market investors, this investment model continues to gain prominence. In December 2019, I had the pleasure of attending the HBS Entrepreneurship Through Acquisition (ETA) conference for my third consecutive year. It’s been incredible to see firsthand the search fund community gaining prominence. I’d like to sincerely thank Harvard Business School and the ETA Club at HBS for producing the incredible event.
For those unfamiliar with ETA, it is a career path in which professionals (often after an MBA program) acquire a profitable lower middle market business and assume the role of CEO to directly run and grow the business’ value. ETA takes the fundamental concepts of traditional private equity and substitutes in high-end MBA talent rather than proven and professional operating partners.
Over 400 individuals attended this year’s HBS conference, largely consisting of current and prospective search fund entrepreneurs, investors, and niche service providers. In addition, former search fund entrepreneurs were in attendance as panelists to share their experiences related to the acquisition and value creation process.
These are my three key takeaways from the conference:
1. The future pool of search fund entrepreneurs is quickly extending beyond the top MBA communities:
- While the search fund model has been historically popular amongst freshly minted MBA graduates, it is predicted that 4x more candidates will pursue the path mid-career rather than right after business school
- The new cohort of search fund entrepreneurs (millennials) value control, independence, and flexible terms, leading to a higher volume of self-funded acquisitions. As a result, LPs are experimenting with various terms to attract candidates towards the traditional funded model
- Former search fund entrepreneurs continue to remain in the community by serving as LPs and mentors for the new cohort
2. “Institutional-grade” ETA LPs are growing, leading to an increase in the availability of capital for search fund entrepreneurs:
- The volume of capital providers in the ETA community is increasing as more family offices and institutional investors test the waters as a means for diversification
- Institutional LPs and Accelerators who are currently involved with the model continue to expand their presence in the asset class by increasing office staff, and adopting innovative recruiting practices to attract higher quality search fund entrepreneurs
- LPs are offering smaller equity checks, leading to an increase in the proportion of debt financing in comparison to historic closed deals
3. Winning deals is getting harder due to changing ETA market dynamics:
- The proliferation of searchers is increasing outreach overlap to the same business owners, making “proprietary deal flow” generation even more elusive
- Owners and operators of lower middle-market businesses are more informed regarding the exit process, resulting in an increase in auction processes and higher multiples
As the ETA landscape evolves, Axial currently serves 68 active searchers, helping them both originate deals and connecting them to Axial debt and equity capital sources to make it easier for them to close funding gaps at closing. We’ll continue to actively support high quality searchers in 2020 (both MBA and otherwise, funded and unfunded), especially those whose approach to deal sourcing overlaps with Axial’s areas of high activity.
For a more comprehensive overview on the search fund model, I would recommend the following resources:
- Buy Then Build: How Acquisition Entrepreneurs Outsmart the Startup Game by Walker Diebel
- HBR Guide to Buying a Small Business: Think Big, Buy Small, Own Your Own Company by Richard Ruback and Royce Yudkoff
- 2018 Search Fund Study: Selected Observations by Peter Kelly, H. Irving Grousbeck, Austin Yoder, and Sara Rosenthal