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Succession can be a complex affair. Retiring owners often have several options: transferring the business to family members, selling it to a competitor, or selling to a financial buyer like a private equity firm. However, family members may not always want to take over, and selling to competitors or financial buyers could threaten the business’s legacy.

Enter the search fund – a strategic alternative that strives to ensure a smoother transition and continuation of a business’s heritage. This investment model is gaining traction as a viable means for aspiring entrepreneurs to pursue their ambitions and for owners to exit without dismantling what they have built.

To gain a deeper understanding of how this model is changing the face of succession planning, we spoke with David To, a former executive at Ecco, a global footwear company, and founder of the recently established, Vancouver-based search fund Lnkd Capital.

The Rise of Search Funds

“Search funds are attractive because they give owners a chance to sell to an entrepreneurial buyer who can step change growth while respecting the company’s legacy,” David says.

Search funds were created at Stanford’s Graduate School of Business in the 1980s to help entrepreneurs overcome financial and operational hurdles when buying a business. This model of Entrepreneurship Through Acquisition (ETA) has gained substantial momentum, especially among MBA graduates and mid-career professionals looking to transition into business ownership.

“As more and more baby boomers seek to pass their wealth down to the next generation, we’re seeing a rise in search funds worldwide. There’s also demand among family-owned businesses for agile buyers who can move swiftly and close deals without disrupting the business,” David adds.

Search Fund Lifecycle

A search fund’s lifecycle includes four key phases, starting with fundraising. In this stage, the entrepreneur, or ‘searcher,’ raises capital to fund their search for a suitable business to buy. Investors at this phase usually understand the ins and outs of search funds and provide capital in return for equity in the future business.

Once the funding is in place, the searcher focuses on industries known for their stable cash flows. For instance, Lnkd is targeting lower-middle market B2B companies in the managed services, distribution, light manufacturing, and energy infrastructure sectors with an EBITDA between $2 million and $8 million.

When a business is acquired, the searcher becomes the CEO, ready to meet the challenges of managing and growing the company. “From the first day, we commit to driving significant growth. This involves investing in technology, crafting new marketing strategies, and fostering innovation. Our aim is to build on the business’s foundation while creating long-term value for all stakeholders,” David states.

Financial Returns and Key Observations

Search funds’ financial returns underscore their potential as profitable investment opportunities. A Stanford University study found that from 1986 to 2021, about $2.3 billion of equity was invested in search funds. This generated roughly $9.8 billion for investors and $2.4 billion for entrepreneurs. These funds achieved an aggregate pre-tax internal rate of return (IRR) of 35.3% and a return on investment (ROI) of 5.2 times the initial investment.

The study also showed that the median purchase price for businesses bought by search funds has increased significantly, with the latest figures hitting $16.5 million. The most common industries targeted for acquisition are software, tech-enabled services, and general business services.

Opportunity and Challenge

The search fund model offers a route to entrepreneurship with less financial risk and the backing of seasoned mentors. However, it isn’t without its challenges. The search phase can be taxing and filled with uncertainty, requiring thorough due diligence, adept negotiations, and considerable patience while potential purchases are assessed. According to Stanford, one in three searches ends without an acquisition. Moreover, as search funds have become more common, searchers are facing stiffer competition.

After acquiring a suitable business, the new CEO must swiftly familiarize themselves with the business’s intricacies, develop rapport with the existing team, and effectively communicate their vision. They must also be ready to make critical decisions under pressure, handle financial and operational challenges, and steer the company towards growth, all while maintaining the trust and backing of their investors and mentors.

Despite these hurdles, the rewards of successfully running a search fund have shown to be significant. As search funds continue to evolve, they stand out as a noteworthy solution for preserving business legacies and offering ambitious entrepreneurs a chance to lead and make a significant impact.

Search Fund Outcomes,
Search Fund Study 2022” (Stanford GSB)