Search fund, explained simply
Investors first fund the search, which typically lasts up to two years. When a target is found, the same investors usually have the first right to fund the acquisition. The model was developed at Stanford Graduate School of Business in the 1980s. A self-funded search is an alternative in which the searcher bears the costs and often uses SBA financing.
Typical targets are stable, profitable businesses with recurring revenue in fragmented industries, where the owner is ready to retire. Searchers are often first-time CEOs, so independent diligence protects them, their investors and their lenders.
The search fund path
ProcessDiligence concentrates in the acquisition step, when investors and lenders commit capital.
Search fund types
| Traditional search fund | Self-funded search | |
|---|---|---|
| Search costs paid by | Investors | The searcher |
| Acquisition funding | Investors plus debt | Often SBA loans, investors or a seller note |
| Searcher’s ownership | Earned over time | Usually larger |
Worked example
A searcher finds a facility maintenance company with $2.5 million of EBITDA. Investors require an independent QoE, which finds that $0.3 million of claimed add-backs are recurring costs and that the largest customer’s contract renews in four months. The searcher lowers the offer and makes the renewal a condition to closing.
Illustrative example.
Why it matters in a deal
Searchers depend on investors and lenders who rely on the diligence. A quality of earnings protects against overpaying and supports financing.
Red flags
- A business too dependent on the retiring owner
- Customer relationships tied personally to the seller
- Thin financial records