By Weini Zhang
Weini Zhang, CFA, FRM, PMP is a second year MBA student studying at Duke University’s Fuqua School of Business.
She is the Managing Partner at Real Value Capital, a US-based investment company providing premier services in public listings, strategic development planning, mergers and acquisitions, and corporate financial services advisory tailored for small and medium-sized enterprises. Before joining Real Value Capital, Weini worked as a Manager in Deloitte’s Financial Services practice in New York for seven years.
On September 7th, 2024, I had the opportunity to attend the Southeast Entrepreneurship Through Acquisition (SEETA) Conference at Georgetown University. This annual event aims to educate MBA students, mid-career professionals, and entrepreneurs on the rapidly growing world of search funds and small-business acquisition. The conference brought together an impressive network of entrepreneurs, investors, and search fund operators. In this blog, I’ll explore the fundamentals of search funds, key stakeholders, and dive into some of the insights shared during the event.
What Are Search Funds?
Search funds are a unique investment model in which an entrepreneur, known as a "searcher," raises capital from investors to fund the process of identifying and acquiring a small or mid-sized business. The aim is to purchase an existing business that has a stable cash flow, strong market presence, and growth potential. The entrepreneur then operates and grows the acquired business, typically with the goal of exiting through a sale or recapitalization in five to ten years.
Unlike traditional entrepreneurship, where founders build a business from scratch, search fund entrepreneurs inherit an existing business. Therefore, one of the primary advantages is a lower risk profile, given the business's operational history and existing customer base. Investors in search of funds find this model appealing due to its relatively lower failure rate compared to traditional entrepreneurship business models.
Key Stakeholders in a Search Fund:
Searchers are individuals or teams who lead the search fund. They are responsible for raising capital, finding and acquiring the business, and eventually running it. Their primary goal is to create value in the acquired business to benefit the stakeholders.
Investors are typically high-net-worth individuals or institutional investors who provide the capital required for both the search phase and acquisition. Their primary role is to support the searcher financially and provide mentorship and strategic advice.
Business Brokers help the searcher find businesses for sale, often acting as intermediaries in the acquisition process. Brokers are key in providing insights into available opportunities and the competitive market landscape.
Legal and Financial Advisors assist with due diligence, negotiating terms, and structuring deals. Legal advisors ensure the transaction is executed smoothly, while financial advisors help assess the company's valuation and financial health.
Qualities of a Good Searcher
A successful searcher requires a unique blend of intellectual and emotional intelligence (IQ and EQ). During a panel at SEETA, it was emphasized that some common characteristics of a good searcher would be:
Empathetic and Humble: Searchers need to step into a business that has been around for years. Understanding the existing culture and empathizing with the workforce is crucial. Humility is also key when working alongside experienced investors and operators.
Emotional Intelligence (EQ): Running an acquired business requires excellent people management skills. A searcher must be able to motivate teams, build trust, and foster relationships with key partners.
Self-Reflective: Constantly evaluating their own performance, a good searcher must be willing to admit mistakes and seek advice when needed. The ability to adjust based on feedback is vital for long-term success.
Tenacity and Desire to Operate: Searchers are inheriting a business with its own challenges and dynamics, hence a deep desire to actively operate and grow the company is essential, as the hard work begins post-acquisition.
Traditional vs. Self-Funded Search Fund
During the event, one of the most discussed topics was whether to pursue a Traditional Search Fund or a Self-Funded Search Fund.
Traditional Search Fund: In this model, the searcher raises a pool of capital (usually around $500,000 per searcher) from investors to cover the operational expenses of searching for a business. This typically includes salary, legal fees, and other costs associated with due diligence. The searcher is compensated with a salary during the search phase and retains equity in the business upon acquisition. Investors take on the financial risk, and in return, receive a portion of the equity in the acquired business.
Self-Funded Search Fund: In construct, for self-funded search funds, the searcher personally finances the search phase, which often gives them more control and a larger equity share in the business once acquired. However, this option involves a higher financial risk for the searcher, as they forgo a salary and cover expenses up front.
Both models have their benefits. A traditional search fund allows the searcher to focus on the acquisition without worrying about personal financial risk. In contrast, a self-funded search can be lucrative for searchers who have the financial means and prefer to maintain control over their equity stake.
The “Golden Rules” of Search
A search fund journey is not without its challenges, and there are several “rules” searchers should keep in mind throughout the process. Some of the key takeaways shared by Trish Higgins from Chenmark, an investor in search fund businesses, include:
Proprietary Outreach: Searchers should focus on proprietary outreach methods, such as directly contacting business owners, rather than relying solely on brokers. This allows the searcher to find unique opportunities that may not be available on the open market.
Focus on Recurring Revenue: When evaluating businesses, searchers should prioritize companies with recurring revenue streams, as they provide more stable and predictable cash flow over time. Recurring revenue businesses also tend to be more resilient during economic downturns.
Avoid Seasonality: Companies with heavy seasonality present higher risks due to fluctuating cash flows. Searchers should focus on businesses with durable demand, meaning there’s a consistent need for the product or service over time.
Partnering is Optional: Many searchers do it alone, but others choose to partner with co-searchers. While partnerships can provide additional resources and shared responsibilities, they can also complicate decision-making. The key is finding the right balance and working with individuals who complement your skillset.
Success Metrics Vary: Success in the search fund model can take many forms. Some searchers measure success through financial returns, while others prioritize the operational growth of the business. The journey is different for everyone, but persistence and adaptability are common traits among successful searchers.
Conclusion
Attending the Southeast Entrepreneurship Through Acquisition Conference was an enriching experience that provided invaluable insights into the world of search funds. From understanding the mechanics of how search funds operate to gaining perspectives on the qualities required to succeed, the conference equipped aspiring entrepreneurs with the knowledge needed to navigate this growing market. The search process requires dedication, strategic thinking, and an unwavering desire to operate and grow a business. The journey is for those with the right mindset and skillset, and the rewards can be extraordinary.
