Search Funds?

Anyone have experience running or knows someone who has successfully run a search fund? I'm an MBA student at an M7 and am looking to go into VC but have been intrigued by search funds recently. Haven't seen a lot of posts on here about search funds and was curious to hear about experiences anyone has had in/around them. APAE ?

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Comments (20)

Mar 8, 2016 - 4:16pm

Some interesting research from Stanford on search funds if you haven't seen already: http://www.gsb.stanford.edu/sites/gsb/files/files-fpp/26891/ces-search-…

I would suggest reaching out to Stanford, they seem to do the best job of keeping track of search funds. They will likely have a list of active search fund companies (and exited) that you could reach out to for an intro.

Mar 8, 2016 - 9:58pm

Appreciate the reply. I've read through a lot of the Stanford stuff as well as the resources on some of the search fund investment firms such as Pacific Lake, etc. Was more curious to get people's thoughts if they've done it or know someone who has and how the experience was.

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Mar 11, 2016 - 5:39pm

I know quite a few people who raised them and seriously looked at raising one with a MBA classmates so I ended up connecting with quite a few Search Funders and investors. It's an interesting opportunity, but the model also has some unique challenges.

To give you a bit of background, I worked in banking for 2 years before joining a PE fund that had a relatively broad investment mandate and did a mix of upper MM and large cap LBOs as well as some growth equity investments. While I did enjoy the investing experience, I became somewhat disillusioned with the the ability to get operational exposure and truly add strategic value (like most people, I vastly overestimated sponsor involvement in day-to-day activities) which was something I was very interested in. At around the same time, I was exposed to the Search Fund model by a ex-colleague who was searching. After learning more about the model, it seemed like the ideal opportunity to get a mix of investing and operational exposure as the thought was to use the search to find a company, run it for 18-26 months, professionalize management, find another business and over time, built a lower MM PE. I become more and more convinced that it was the perfect opportunity for me and went into business school with the hope of finding a partner (I knew I wasn't interested in doing this alone).

Luckily, one of my best friend and classmate turned out to be very interested as well so we decided to partner up and spent the spring and summer of our first year exploring the idea. The search fund community is beyond helpful, I can't count the number people with no connection to us whatsoever who took a lot of time to discuss their experience with us. We got some interns for the summer (it'll come back to this) and developed marketing documents and a detailed sourcing strategy and starting networking with investors. We got to the point where we were negotiating terms and ultimately decided it wasn't for us. Here's some of my thoughts on the model and why it turned out not be something I wanted to pursue.

Raising the funds: this was my biggest worry coming in, even though I had been told it was relatively easy. Turns out that if you are committed, know your stuff and are willing to spend a bit of money travelling to meet investors, it won't be that hard. There's a few law firms involved and they all work on a fix fee. The only caveat I would add to this is that a large % of search funders do it out of their MBA so there's a bit of a "normal" fundraising period and during which search funders somewhat compete with each others. While competition for dollar is not a huge issue (there's more than enough institutional and HNW money available), investors all know each other and tend not to back more than a team or two with similar strategy at the time. The typical Search Fund investor will not allow you to professionalize management and turn yourself into a sponsor though so building my own PE fund went of the way (it's possible to do that if you're willing to self fund the search and get pledges to invest, but that's another story).

Finding a deal: This is where things start to get tricky. On paper, finding undervalued businesses ran by retiring baby boomers sounds like the perfect opportunity. In practice, it's very hard to find a business that has high recurring revenue, growth potential (there's a reason most small businesses stay small, it's because they aren't a lot of growth opportunities) and a diversified customer base and buy them for 4-5x. So you're stuck looking at shit businesses. The search process is also wildly inefficient. While it's very easy to get free interns to help with sourcing, setting up the sourcing infrastructure and building a network is extremely time consuming and takes time to start yielding results (there's a strong bias toward finding proprietary deals so no auction / broker). A pretty significant % of search funders don't find a deal during their 24-30 search window. But the biggest issue is geography, you have to be open to a deal anywhere and move to that location for the next 4-6 years. I will admit I was pretty positive about being able to find something in my preferred location (my gf isn't super mobile), but EVERY single search funders we spoke to stressed that that is just not realistic. My gf has a good job and high earning potential so there's no chance she'd give that up so I was looking at a consultant lifestyle for 4-6 years and / or long-distance relationship which isn't ideal when you are in your thirties.

Running the business: It's hard to grow a small business. Pretty much everyone we spoke to struggled with growth due to being in a mature market, capital constraint, lack of quality people, etc.

Returns / comp: Looking at the Stanford data, it seems returns are very high, but you strip out 2-3 outliers (Asurion & other), the returns really don't look that attractive anymore, especially on a risk / reward basis. Over 50% of exits were done at a loss and they are really very few success stories. Using the data, we built a probability based model and the expected comp for what was realistically a 6-8 years project just wasn't nowhere near worth the risk.

Ultimately, the entrepreneurial aspect of the model was a big motivation, but I realized that it was the wrong way to realized this ambition. However, doing this gave me the confidence to pursue something truly entrepreneurial and I have been thinking of start-up ideas ever since. Unfortunately, the MBA raped my finance to the point where I desperately needed an income post graduation (which is why I am back to what I am used to), but in a year of so, my finance should be back to a healthy state and I should be in a position to be able to seed myself / support myself for 12-18 months while building something if I decide to.

Sorry for the disjointed thoughts, I have been meaning to write all week and got busy and it is Friday after all. Feel free to pm me also if you want to discuss in more details.

Mar 11, 2016 - 9:04pm

Incredibly insightful, thanks for contributing.

Not even interested in the search fund world and this was a fascinating read.

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Mar 14, 2016 - 10:02am

Thanks, that's a great story. Nice to see you had the objectivity and intellectual honesty to follow where your analysis led you rather than barreling ahead.

One thing I've been curious about - what was interaction like with the institutional search fund investors (Pacific Lake, Anacapa, Peterson, etc.)? How much are they willing to invest per search ($ and % of equity)? Do search funds typically put debt on a company as well?

Thanks again

Mar 30, 2016 - 3:42pm
Capitol86:

Thanks, that's a great story. Nice to see you had the objectivity and intellectual honesty to follow where your analysis led you rather than barreling ahead.

One thing I've been curious about - what was interaction like with the institutional search fund investors (Pacific Lake, Anacapa, Peterson, etc.)? How much are they willing to invest per search ($ and % of equity)? Do search funds typically put debt on a company as well?

Thanks again

Sorry, was away on holiday. the typical search fund investors all know each other and they tend to move as group (ie. if one of them is in, they tend to follow). The typical search fund will have 7-15 investors. The impression I got from talking to these people is that they want to deploy as much as possible (given they like the deal). Using debt to fund to acquisition is an integral part of the search fund model. People usually try to have the seller underwrite a seller's note in addition to a typical banking facility for total debt of around 2x.

Jun 22, 2017 - 2:21pm

Great write-up, and I don't think it was disjointed at all. What did you guys end up doing?

Apr 21, 2019 - 11:56am

Thank you so much - very helpful indeed
A couple follow-up questions: How does comp look like? I.e. how much are you allowed to take as salary as an operator and what is the returns threshold to start cashing in equity?

How do you get interns and what type of interns do you get? I.e. unpaid undergrads? Paid? How many interns do you need?

Thanks!

Apr 24, 2019 - 7:45am

Keep in mind that there's flexibility with the model and that terms are of course negotiated so things can vary. Also keep in mind that I looked into this ~5 years ago so my data could be a bit dated.

Comp: during the search phase, essentially the lowest you can live on since funds advanced during the search period usually get a 50% step up once a target is found and that step up eats into the principal's equity (ie. you have to pay it back before you get any value). FYI, we had budgeted $85K each (we were 2).The idea behind the model is that you'll make the vast majority of your return through equity, not cash comp so depending on the size of the company, it's cash flow, the size of the management team, you can think of something along the line of $125k-$200K / year for the 4-6 year holding period. Your investor will generally sit on your board and have input on your cash comp.

Equity: typically, searcher's equity will be structured into 2 tranches, sweat equity and performance based (ie. options). Some investors may split the options into 2 tranches, one with a lower return threshold and the other with a higher (ie. home run options). Back when we were looking into this, investors would get a 8% liquidity preference so you would start cashing in after that.

Interns: I think it really depend on your strategy and how broad will your search be. Essentially, interns allow you to greatly increase your sourcing network and identify and reach out to way more companies. Our interns were unpaid undergrads, which I think is the most common (again, given the way the search is funded, you really, really want to minimize expenses). We planned to pay a bonus if we were to close a deal. That being said, a team of searchers I am close with ended up taking some of their interns full-time (and unpaid, their parents essentially paid them in the hope that the experience would turn into a good finance job).

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Mar 8, 2020 - 1:48pm

How much do these law firms generally charge to get your entities all set up? And can you share the names of any or how to find firms that offer this?

Mar 10, 2020 - 10:50am

Keep in mind my data is a bit dated, but we were quoted $10K for standard docs (which in reality ends up being ~$15K because nothing is ever standard).

A quick google search seems to indicate that interest from law firms in the space has increased so it seems there more choice. We were recommended these 2 firms, doesn't mean other aren't as good / can't do it, but these 2 have a lot of experience in the space.

https://www.sidley.com/en/services/private-equity/search-funds
https://www.goodwinlaw.com/services/practices/search-funds

Mar 14, 2016 - 11:05am

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Jun 22, 2017 - 2:22pm

Search funds (Originally Posted: 06/09/2015)

What is everyones thoughts on working for a search fund? I think its a good mix of start up atmosphere and the private equity state. Interested to see what others thing.

Jan 22, 2017 - 3:23pm

Search Funds are a very common career path for entrepreneurial minded ex-bankers and mid-level managers after they get their MBA. There are a variety of options to get started with buying a company and Search Funds are really just the beginning. Some helpful resources are SearchFund Dot Org as well as Equire Dot co.

Oct 13, 2021 - 6:20pm

This is an old thread, is anyone on an active search or end up have a successful search (i.e. buying a business)?

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Oct 14, 2021 - 7:51pm

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