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An introduction to Search Funds/entrepreneurship through acquisition

The popularity of search funds has reached new levels in recent years. In this insight (the first of our fortnightly search fund series) we outline their key features and what is driving their increased popularity in the UK.

What is a search fund?

The search fund concept/Entrepreneurship through Acquisition originated out of the Harvard and Stanford business schools in the 1980s. It essentially is a specialist investment vehicle which sees investors back a promising entrepreneur in waiting (or pair of entrepreneurs operating as a partnership) to go out and acquire a business and step in as CEO. The new CEO is tasked with growing the company to new levels before an eventual exit some years down the line.

If operating under the traditional model, then the entrepreneur (otherwise known as the “searcher”) will typically initially raise “search capital” at the start of the process. This will typically be a lower amount (say £200k - £500k) and used to provide a salary to the searcher and fulfil other costs while they attempt to identify a suitable company to acquire (such as due diligence and other fees). This initial search phase normally takes 1 – 2 years. Once a target has been identified, the searcher will raise a larger balance of “acquisition capital” to fund the transaction. Typically the transaction will see 100% of the share capital of the company acquired – although sometimes we do see sellers willing to retain a minority stake to participate in future growth.

Once the acquisition has been completed, the searcher will step into a leadership role and look to implement gradual change to grow the company. The searcher themselves will typically acquire around 8% of the share capital of the company initially but will have opportunities to grow this through meeting certain performance targets.

About the author

George Thresh

+44 (0)207 710 0935
threshg@buzzacott.co.uk
LinkedIn

What is a search fund?

What are the benefits?

Why have they been growing in popularity and what are the benefits?

Certainly, over the last 12 months, we have seen an explosion of activity in the search fund sector, with more UK deals complete or in progress than ever before. Search funds provide a significant number of benefits to investors, exiting company founders and searchers themselves, and it is greater education on and awareness of these benefits which we believe has driven the increase in popularity. Below we have outlined some of these benefits:

Searchers – the most obvious beneficiaries of the model are the searchers themselves. They're essentially able to skip the risky and often painful start-up phase of a new company and jump straight into the established CEO role (with the usually significant salary that comes with it). Most searchers will have completed MBAs and have other business and sector experience to enable them to drive growth with an innovative new approach. Indeed the model is often referred to as “Entrepreneurship through Acquisition”, with searchers using their entrepreneurial drive to take established companies to new heights and to achieve better results.

Investors – put simply, the key benefits for search fund investors are risk and return. As search funds typically acquire established, stable businesses the asset class is typically less risky than Venture Capital (which focuses on investment into start-ups), with a risk profile more akin to that of traditional Private Equity. Returns have been very attractive with studies by Stanford Business School and IESE Business School showing an aggregate IRR of 36.7% and ROI of 8.4x. This sees more and more investors recognising the value of the asset class and being willing to embrace it. Many investors will in fact be former searchers themselves who have successfully exited using the model in the past.

Availability of capital – indeed leading on from this, the level of capital available for searchers in the UK from investors/lenders has never been greater. We're now seeing far more institutionalised investors supporting searchers on the equity side and lenders willing to embrace the model and provide debt. In previous years we were seeing only a select few debt providers involved whereas now we will frequently see competitive processes with multiple lenders pressed to offer the best possible terms. This availability of capital is crucial in enabling search fund transactions to happen. It also reduces the need to rely on vendor loans which can sometimes prove a stumbling block when putting together a competitive offer to the target company founders.

Exiting founders – the key attraction of the Search Fund model to exiting founders is that because the searcher will be stepping in as CEO, it provides a succession path which may not otherwise have been present. It is particularly useful in retirement scenarios where there isn't a management team in place ready to step up. In these situations, traditional private equity isn't the most obvious fit meaning the only other exit route would be a trade acquisition which could lead to staff cuts and an erosion of the culture that has been built up over a number of years. Therefore, more and more founders are recognising the potential benefits of the model and are willing to entertain approaches by searchers.

Therefore, the Search Fund case is compelling for all parties involved in the right situation. At Buzzacott we see more and more instances of the “right situation” arising. Furthermore, education around the model is now more widespread (many European Business Schools include it in their MBA programmes) meaning founders are more open to exploring it as an option and investors are more active. In just the first three months of FY23 we have been involved in six Search Fund transactions (either completed or currently ongoing), and with multiple other transactions on the horizon, have high hopes for the future development of the sector in the UK.

Search funds: a complete guide

We've created a series of articles exploring the key things you need to know about search funds, an innovative and growing asset class which can provide a great outcome for all parties involved when utilised correctly. Read below.

View the series

How can we assist?

How can Buzzacott assist on a Search Fund acquisition?

The Corporate Finance Team at Buzzacott have great experience providing financial due diligence and transaction advisory services to searchers looking to make acquisitions. We view the due diligence process as establishing whether the target is a company you want to acquire and the transaction advisory service as using learnings from the diligence process to negotiate the best possible deal. This is typically achieved through making adjustments at the enterprise to equity value bridge stage, establishing a cash requirement or identifying additional debt items.

The Buzzacott tax team also have experience in both performing tax due diligence to identify potential issues in the company and structuring the deal/acquisition vehicle so that it works most efficiently from a tax perspective. This is often invaluable in cases where a Search Fund has multiple different investors, often based in a variety of countries.

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