What I learned from the search fund conference
What’s a search fund, and why do I care?
As many of you know, I am a marketer at a startup which is why I write about startups and equity compensation with some frequency. Although I love my job, someday I’d like to leave the startup world to be an entrepreneur. My problem is that I don’t have any genius ideas for a business. I am into entrepreneurship, marketing, finance, and finding efficiencies… but I don’t really have a passion for creating an idea or business from scratch. So where does that leave me? Enter the search fund.
Search funds operate like small private equity funds. 1-4 people go out and raise money to look for a business related to their experience that they can buy within a given price range. Ideally, it would be a business that is under-managed or otherwise ripe for some improvement. If the searchers don’t find a business that matches their criteria, or if it’s too expensive, or for any other reason they don’t succeed, then they wind down the fund and pursue other activities. Obviously, their investors lose the money they put into the fund to finance the search. It’s a bummer, but it happens.
On the other hand, if the searchers find a business that fits the bill, then they go through their due diligence and raise more money to purchase the business. Their original investors get a larger slice of the equity pie than the dollar value of their investment would justify, since they took the risk of financing the original search.
Then, the searchers run and improve the business. In return for their time and effort running the business, they are given a salary as well as a large share of the business that they can earn out over time, or when certain milestones (like a sale) are achieved. Most search funds have a target of 3-6 years between purchase and sale, with the idea that the searchers would be able to turn the business around -or significantly improve it- within that time-frame.
Search funds seem perfect for me
Obviously, the search fund is a very well matched vehicle for my skillset. I am not someone who thinks of crazy product ideas. But, I am a good manager, I have valuable experience in marketing, and I have some financial acumen. I could use all of these skills in combination to drive efficiencies and profit at nearly any company. Well… that makes me sound a bit conceited. I could certainly use those skills to drive value at SOME companies.
Earlier in the year when I first found out about them, I wrote about search funds, and a couple of people saw my post and invited me to the Search Fund Conference in Boston, sponsored by Harvard Business School. Obviously, I grabbed a ticket. Here’s what I learned.
Search funds buy smaller businesses, but they can grow into monsters
One of the first things that I learned at the conference was what the average deal looks like for a search fund. Generally, the ideal search fund target has about $750k-$2.5m in EBITDA, with an average purchase multiple of 4.1x. That means that most search fund purchases are in the $5-$10m range. That number makes sense to me, but what surprised me was the scale that some of these businesses can grow to.
During the panel on multi-entity strategies (which I will describe below), the moderator wrote down the size in revenue and EBITDA for the businesses that the panelists were running. You can see in the image below that all of the panelists had grown their businesses to over $30m in revenue, and $4.5 million in EBITDA. Alex, who you can see smiling for obvious reasons in the front, purchases and runs Burger King franchises. With over 80 locations, he and his partners have very quickly built a business with $500m in revenue, and $80m in profit. He is undoubtedly highly leveraged (to be fair, he didn’t say), but nevertheless the result is impressive. Depending on debt, his company could easily be worth $300m.
I should note that this result is unusual, but all of the numbers described in this panel were quite impressive considering that they were built from “small” businesses, or by accumulating many small businesses.
There are many different ways to search
A search fund is as broad of an entity as a private equity firm. What it does and how it works is completely up to the searcher. Search funds can be bucketed by:
Traditional - Find investors to finance the search then raise money for the purchase
Self funded - Finance the search on your own, and then either raise money to buy the business or self fund that as well
Accelerator - There are accelerators that take a portion of the business in exchange for back office assistance, networking, processes, advice, etc.
Multi-entity - Multi entity strategies seek to purchase multiple businesses in related industries and combine them, or purchase lots and lots of businesses in the same industry (like franchises).
Industry focus - You can narrow the search to any industry, or as is often the case, a set of 3-4 industries that match the searchers background in some way
Geographical focus - Are you looking across the country or in one single place?
Search is complex
Even though you are buying a small business, there are a lot of steps to the process. While attending one of the sessions on due diligence and purchase negotiation, I learned that the range of transaction costs (legal, accounting, insurance, and origination fees) for a search fund go from $250k to well over $500k. Luckily, many of the professionals who work in the industry will defer their fees to make this financially possible, but it is certainly a cautionary number when you consider that many deals will fail. Small companies come with small company problems, like bad record keeping, fraud, and workers comp. Weeding out the bad companies from the start is an imperative for success.
So are search funds going to be my next career?
It’s hard to say after one conference. I learned a lot, and there are certainly things I like about search. It matches my temperament and desire to be an entrepreneur. The model is a little more secure than starting a business from scratch. There is an established community. There is certainly potential to scale a search business to a massive size. But, I need to do a lot more research and talk to a bunch of former and current searchers before I can be sure.
I will definitely be writing more about search in the future, though!