Search Funds: CES: Stanford GSB

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Search Funds

Search Fund Primer

For those contemplating pursuing a search fund, or investing in one, the CES has created a practical guide to answer the most frequently asked questions. The Primer aims to provide an unbiased view of the benefits and challenges, explains the model from the entrepreneurs' and investors' perspective, and gives many operational and execution tips from previous search fund entrepreneurs.

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Conceived in 1984, the search fund is an investment vehicle in which investors financially support an entrepreneur's efforts to locate, acquire, manage and grow a privately held company. MBA and law school graduates are using this approach more and more frequently to become entrepreneurs, often shortly after graduation, despite a relative lack of operating experience.

Since 1996, the Center for Entrepreneurial Studies ("CES") at Stanford Graduate School of Business has conducted a series of studies on the performance of search funds (see links below). The CES has identified and tracked over 95 search funds raised since 1984, many of which have purchased companies successfully in the United States or United Kingdom. A 2007 CES analysis of 61 qualifying search funds found investor returns to be an average 52% IRR.

Go to the Search Fund Study 2007 [ PDF 101KB]
Go to the Search Fund Study 2005 [ PDF 144KB]
Go to the Search Fund Study 2003 [ PDF 96KB]
Go to the Search Fund Study 2001

Professor Irv Grousbeck, who helped conceive of the search fund and advises many of the entrepreneurs, expects that use of the search funds will continue to grow: "It's the most direct way I know for aspiring MBA entrepreneurs to get into business for themselves. And now that there are many experienced search-funders out there, those who have gone earlier are advising those who have come along more recently. Our objective is to have the search fund model grow, flourish, and be self-supporting, as one wave helps the wave behind it."

The search fund process consists of up to four stages: fundraising, search and acquisition, operation, and eventual event to provide shareholder liquidity.

Raising the Fund

In a search fund, capital is raised in two stages: (1) to fund the search ("search capital") and (2) to fund the acquisition of a company ("acquisition capital"). The search capital is used to pay the search fund principal(s) a modest salary and cover administrative and deal-related expenses over a two to three year period while he (they) search for an acquisition. Once a target acquisition is identified and negotiated, the search fund entrepreneur(s) raises the acquisition capital to purchase the company.

When raising the search capital, the search funder should strive to locate investors who can provide advice, counseling, creditability, and above all finances for the search and acquisition. A search fund is typically raised from 10 or more investors who each contribute $25,000-$40,000. In exchange for the initial search capital, each investors receives: (1) the right, but no obligation to invest pro-rata in the acquisition capital, and (2) conversion of the search capital, typically on a stepped-up basis (e.g. 150% of the actual investment) into the securities issued as the acquisition capital.

Finding a Company

The following criteria are likely to make a business attractive for acquisition:

Profitability.
Growth industry.
Predictable, stable, and recurring revenue.
High EBITDA margins.
Stable contractual relationships.
Simple and easy to understand.
Reasonable pricing.
Enough candidates in the industry available.
Financing available.
No overly dominant competitor or customer.
Limited landscape risk (including technology obsolescence, regulatory risk, legal risk, environmental risk, major cyclically, fads/trendy).
Low to medium technology product or service sectors, rather than the high-tech tech sector
Industry is profitable, not in decline, and attractive to creditors.
Growth potential via follow-on acquisitions, geographical expansion, and/or product/service extension.
Competent middle management willing to remain.
Long product/service life cycles that are not subject to rapid technological change or obsolesce, and that do not require substantial additional R&D.
Product/service differentiation exists or can be created.
Cash flow and assets sufficient to attract and service proposed debt.
Opportunity for liquidity in 4 to 6 years.
The opportunity to create superior returns through revenue growth, operational efficiencies, scale, financial leverage, and improved management techniques.

Center for Entrepreneurial Studies

Related Site

Search Funds

Search Fund Primer

Search Fund Videos

Raising the Fund

Finding a Company

Center for Entrepreneurial Studies Search Fund Library Contents

Search Fund Panel Transcriptions

Search Fund Panel Videos

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