M&A Market | Know your buyer
Recently, there has been more discussion around search funds from M&A experts that are a bit more sell-side oriented (for example, Nancy Fox -The Fractional Fox, Kirk Michie and Pat Linden). Search funds are a buyer category of ever-increasing importance in the the lower middle market, so understanding them as a seller is critical, as search funds are encountered in almost every M&A process.
In this first post in a mini-series on search funds, Let's start at the beginning. What is a search fund?
It depends
TRADITIONAL SEARCH FUND. A "traditional" or "core" search fund is an investment fund led by 1 or 2 searchers with the support of a small number of investors. The goal of the fund is for the searcher(s) to find, acquire, operate, and lead a business with a holding period of around 6-10 years. {Note that a variant is the long-term hold fund, which plans *from inception* to hold for a longer period, such as 10-20 years.}
A traditional search funds provides a quicker path to the CEO seat, and the potential for attractive returns. Also, core search funds offer searchers salaried compensation during the search phase (we'll turn to search fund phases in a subsequent post).
SINGLE-INVESTOR FUND. A single-investor fund is similar from an economic standpoint, but has a single investor rather than a small group. That investor may be a private equity firm, a family office, an individual, or an accelerator program. In the latter case, the searcher may be referred to as an Entrepreneur in Residence (EIR). Accelerators often provide searchers with training; mentorship; database and other information tools; and introductions for lending, legal, and financial assistance. With that level of formalized support, accelerator-affiliated searchers tend to be very sophisticated buyers.
SELF-FUNDED SEARCHERS. Just as it sounds, self-funded searchers rely on their own funds to finance search and acquisition, and usually rely more heavily on debt financing and maintain a greater equity position. Self-funded searchers may search full time or part time while maintaining other employment. As you'd suspect, self-funded searchers tend to have much greater flexibility as far as target size, location, and industry.
Don't let the names fool you as to prevalence. According to Stanford University Graduate School of Business's excellent 2024 search fund study (attached, and the basis for many posts in this series), less than 700 known core search funds have been formed since 1984. It's safe to say that self-funded-searcher numbers dwarf that number.
In the next post, we'll continue a focus on the seller-relevant characteristics of the search-fund type.