Have you ever been completely baffled?
It happens to me quite a bit.
Despite running this site for a decade, I still come across unfamiliar lingo and terminology.
It happened a while back when a reader wrote in to ask what I thought about “search funds.”
I had no clue what they were, so I had to Google the term, read through a few reports, and give a rough answer.
But then, a few months later, a reader with firsthand experience working at a search fund volunteered for an interview – so I went straight to him for the full story:
What is a Search Fund?
Q: I normally start with your background story, but I think we need to define “search fund” first.
A: Sure. A “search fund” is an investment vehicle started by an entrepreneur who wants to acquire, operate, and eventually sell a single business .
Here’s how search funds compare to private equity funds :
- Both types of funds raise capital from outside investors .
- Both types of funds use a combination of debt and equity , or sometimes entirely equity, to acquire companies.
- Both search for companies with specific characteristics in terms of revenue, EBITDA, margins, industry, and business model.
- Both plan to exit their investments in about the same time frame (5-7 years).
- A search fund exists to acquire a single company . There is no “portfolio” – you raise capital, use it to acquire one company, and that’s it.
- You don’t need as much experience to start a search fund; ~75% of founders are under the age of 36. Most come from private equity, investment banking, management consulting, or general management, and some have MBAs.
- Search funds acquire much smaller companies . Most PE firms won’t go below $5 million in EBITDA , but search funds will go as low as $1.5 million.
The typical company acquired by a search fund might be worth between $5 and $30 million USD, with a median value of $10 million (and, if you’re curious, a median EV / EBITDA of 5-6x, EBITDA of $1.5-2.0 million, and EBITDA growth of 10-20%).
Historically, search funds have targeted services companies, but IT and healthcare acquisitions have become more common over time.
- Private equity funds want managers who will stay on and operate the company post-transaction , but search funds look for companies where the leadership team wants to leave – so the search fund entrepreneur can step in to run the business.
Q: Thanks for that thorough answer.
It seems like entrepreneurs start search funds if they want to operate an existing business without starting the business.
And owners sell their companies to search funds if they want to quit, but they can’t go public or sell to a large company or traditional PE firm.
A: Yes, that’s correct.
Search funds exist to fulfill specific market needs, which you just described.
Q: OK. So, how did you get into this industry?
A: Going into undergrad, I was initially interested in politics and did an internship in the U.S. Senate.
But living and working in D.C. made me less interested in politics and sparked my interest in finance and investment banking instead.
I began learning everything I could about the industry, and I did an internship at a search fund, assisting with lead generation and outreach, and then I re-joined in a paid, full-time role.
Q: And how do most people get into search funds?
A: Most people who start search funds do so as solo entrepreneurs or with a partner.
After they start the fund and raise capital, they need help with everything: Researching industries and companies, finding deals, arranging financing, completing financial modeling, conducting due diligence, and so on.
Search funds are small businesses , so they do not care about whether you’ve worked at Goldman Sachs or attended Harvard.
All they care about is your ability to get the work done .
So, if you’re an ambitious undergrad, and you want deal/modeling experience, you could reach out to search funds and win offers if you’re persistent enough.
At the undergraduate level, most people who join existing search funds are unpaid interns who want to gain experience they can leverage to win roles in banking or private equity .
On the Job at a Search Fund
Q: That sounds like the Wild West.
Let’s talk about the job itself – how do you raise funds initially?
A: We start by creating a “private placement memorandum” and defining the type of company we’re looking for and how we plan to finance the deal, run the company, and exit.
Then, we go out to institutional investors and funds that invest in search funds and pitch ourselves . “Friends and family” may also enter the picture.
Typically, investors purchase several “units” of search capital for $30,000 to $40,000 each; the average fund has 10-20 investors.
Q: OK. What next?
A: Believe it or not, raising money is the easy part of starting a search fund: It’s not that much money, and it’s distributed across a dozen or more investors.
After that, we enter the “Search and Acquisition” phase, where we look for an undervalued or undermanaged business to acquire.
The search fund entrepreneur spends the majority of his/her time reaching out to potential sellers, gauging which companies fit the fund’s criteria, and asking the outside investors and advisers for their views.
If you’re a junior intern, you’ll spend most of your time in this phase getting the fund’s systems and processes up and running.
For example, you’ll make sure that the fund has a solid deal pipeline and that intermediaries and business brokers in your area know about you.
As sellers start coming in, you’ll spend time evaluating them, requesting financial and market information, and building simple models to assess deals.
Q: And if you find a company that meets your criteria, what happens next?
A: If we decide to do a deal, the equity portion of the purchase price might be between $1 and $10 million, which represents about 40-75% of the total.
So, just as in traditional leveraged buyouts , we have to seek financing – usually in the form of bank loans – for the rest.
If the deal closes, the search fund principals become “top management” at the company and attempt to grow the business, increase its margins, and eventually exit the business.
Q: OK. It sounds similar to traditional private equity, but with much smaller companies and more of an operational focus.
A: That’s one way to think about it, but don’t forget about the much lower compensation as well!
The entrepreneurs who start these funds take massive pay cuts when they begin searching for companies – maybe a 50% discount to what they could earn in other post-MBA roles – because there isn’t much money to go around at that stage.
Then, they work as hard and fast as possible to find a company before time runs out .
If it takes too long to find a company, they might have to return capital to their investors and shut down the fund.
But if they find a company to acquire, they can own up to 25-30% of it without spending a dime, personally, on the deal.
In an exit, that 25-30% stake could be worth a huge amount if everything goes well .
In short, it’s a high-risk, high-potential-reward role.
You’ll make more money than if you start a business from scratch, but you will not earn much until you find a company, acquire it, run and improve the business, and then sell it.
That entire process might take up to ten years, which is why MBAs don’t exactly flock to search funds.
Are Search Funds Worth the Risk?
Q: You make the role sound risky and difficult, but data from the Stanford GSB says that search funds, as an asset class, have produced an aggregate ROI of 8.4x and aggregate IRR of 36.7%.
What am I missing?
A: A few things. First off, the median fund returns only 1.0x of the initial capital raised; outliers have pushed up those returns.
Keep in mind that only ~250 search funds were founded between 1984 and 2016, so there isn’t a ton of data to go on.
If you look at all the funds raised to date, only around 50% have found a company to acquire.
Close to 20% quit searching and returned their capital, and 30% are “still searching.”
Of the funds that acquired a company, 27% have exited, 15% shut down the business, and 59% are “still operating.”
Because of the low number of search funds and the small amount of capital raised, a few highly successful outliers have produced high aggregate returns.
Q: Thanks for clarifying.
What makes the business so hard?
A: Unlike some businesses, such as starting hedge funds , the difficulty does not lie in fundraising, but in finding the right company .
It sounds “easy” to find a small business with a few million in revenue and a retiring owner, make him an offer he can’t refuse, and acquire the company.
But a few problems immediately come up:
- No Reason to Sell – Many people in this position have niche businesses that require little ongoing effort to run. They have no incentive to sell unless you offer a great price , the business isn’t doing so well, or the person is on his/her deathbed.
- Lack of Growth Opportunities – Small businesses are “small” for a reason: They get to a certain size, tackle a narrow market opportunity, and… stop growing. It’s often easier to grow a bigger business that’s addressing a broader market.
- Geography – Many of these companies are in The Middle of Nowhere, and you’ll have to move to that location for the next 5-7 years as you run the business. So, you have to be flexible with your geography, which might wreak havoc with your personal life.
Q: All that makes sense.
So, bottom line: Who would be a good fit for search funds, and who would not?
A: If you’re an undergraduate or recent graduate, search funds are great for gaining deal experience and “something interesting” for your resume.
Many students do internships early on and then leverage them to win IB or PE roles in the future.
There’s also far less competition for roles at search funds since they don’t have much publicity (although that may change after this article…).
But to do well, you have to be a hustler . If you want structured experience and step-by-step instructions, stay away!
Also, many internships at search funds are unpaid , so you have to be in a financial position to afford that.
If you want to start a search fund, you must have specific operational skills that will improve a business, and you must be willing to take on a good amount of risk – but not quite enough risk to start your own company .
And, as I mentioned above, you have to be very flexible with geography, timing, compensation, and other criteria.
Q: Great. Thanks for your time!
A: My pleasure.
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Hi there I am trying to cut down my resume to one page I am about 7 lines off. Should I cut a section on Sports Direct – retail sales to make it fit or cut something from leadership. At the moment I have 3 work experiences and 3 leaderships.
Apprecate your help.
Cut the section on retail sales. But you probably need to remove other experiences as well since you should not go above 3-4 separate entries, especially as a university student.
Brian and the team:
How do you study the stock market and understand the technical stock market questions that may be asked at an interview?
That is a really broad question that entire books and textbooks have attempted to address before. My advice would be to get some of the classic books on investing and then start making your own trades using small amounts of money to learn the ropes. Read as much as you can about the markets, but trading practice is essential and the only way to really “learn” the markets.
Hi Brian and team
I recently just worked at a Private Equity/Venture Capital/Asset Management Company in central London called “Foresight Group”. I was working as an admin/research assistant ‘analyst’ in the investor relations department. How would you suggest I describe my experience on my resume, what I should I call it on my Resume, to leverage the best result?
Also I have only worked for two weeks there, I could be working there longer, does this matter at all?
P.s I am a history major from a non-target school (I could if you’d like be a example/template, for getting in the door if you like?)
You can list it as “Private Equity Intern” so that you include a few important keywords. Leave out the investor relations part, even if that’s the department you were in, because “Private Equity” will seem a lot more relevant.
Also, you should probably describe the group’s business if it is not a well-known firm.
Thanks a lot Brian, I’m very grateful for your help (replies, articles and videos).
Hope you’re doing well. I’m currently an undergrad studying Econ in London and am also really interested in AM. I’m also from a non-target and would love to have a quick chat as to how you got the position. Please contact me on email@example.com if you’re free for a quick chat.
I am going to be a sophomore at a good school, but not a target school with a 3.70 and good involvement. What kind of internships should I be looking for in order to better position myself for bulge bracket I-Banks come my junior year. I was currently looking into boutique investment banks, even after reading your article on why they won’t hire me. I am curious to know if I am wasting my time and effort applying the boutique banks and what internships will look best on an IB resume?
Boutique banks, small PE/VC firms, search funds, corporate finance at local companies, valuation work at independent (non-Big-4) firms, etc. The point of that article is that you can’t just go to a boutique and say, “Hire me! I go to a good school.” You need specific reasons why you would save the bank time/money or otherwise make things easier for them, which most students don’t even try to come up with. If you present yourself correctly, you’re never wasting your time by applying.