What is a Search Fund?
If you’re not familiar with Search Funds, they are an investment vehicle employed to acquire one’s way into entrepreneurship using privately raised capital. This method of acquisition has become incredibly popular in recent years and is touted as a faster way to successful business ownership over building a company from scratch. If it’s a faster and smarter way to acquire a business, why do manufacturers hate the Search Fund Model?
Search Fund Statistics
Before we examine the reason manufacturers don’t like the model, let’s look at some Search Fund statistics. In 2017, a Harvard Business Review Study revealed that 90% of Search Funds failed. A 2022 Stanford Graduate School of Business Study reported that 11% of search fund acquirers experience litigation with the Seller post-acquisition. The median age of a search fund acquirer is 32, without prior business ownership experience. They come from the following industries:
- Private Equity 27%
- General Management 12%
- Management Consulting 11%
- Investment Banking 11%
- Sales 6%
- Operations 5%
- Military 9%
The Stanford Study also reported the following statistics:
- The average fund size is $53.4 million.
- The top five industries for search funds are healthcare, business services, consumer/retail, technology, and industrials/manufacturing.
- The average time to complete an investment is 13 months.
- The average hold period is 4.3 years.
- The median return multiple on invested capital (MOIC) is 2.7x, and the median internal rate of return (IRR) is 34%.
- The most common exit routes for search funds are strategic acquisitions (54%), followed by management buyouts (21%), secondary buyouts (9%), and IPOs (4%).
Why Manufacturers Hate the Search Fund Model
As an M&A professional selling nationally and exclusively within the manufacturing sectors for the last 30 years, I can answer this in one word: EXPERIENCE.
The majority of manufacturers seeking to sell their companies are retiring. They’ve typically invested 20-40 years of their blood, sweat, and tears in the business. Selling the business is like letting go of one of their kids. They want to understand that it will be left in good hands, that it will survive them, and that it will grow and thrive. They also are highly concerned about their staff and want to ensure they’ll have future growth opportunities.
How do you explain to a retiring seller that someone who has never owned anything and is using other people’s money to mitigate their risk is the right person to entrust their business to? I’m not saying it’s impossible, but it’s very difficult. As the M&A professional tasked with vetting potential acquirers both professionally and financially, I can tell you that I lose credibility with clients if my firm puts inexperienced acquirers in front of the client. They perceive it as a waste of their time. Too harsh? I’m sure it might seem that way to those who want to be entrepreneurs. The bottom line is that my fiduciary responsibility is the client, the retiring manufacturer.
My office speaks to hundreds of potential Search Fund acquirers each year. Most will argue that their investors are highly experienced and will be their advisors and board members. But they are still charged with running the day to day, not the investors, and there is still a 90% failure rate.
If the M&A professional specializes in manufacturing, their client will have multiple offers to choose from that include proven success stories and those who don’t need to use leverage to make the acquisition. Retiring manufacturers have more respect and are more comfortable selling to this type of buyer. So, in conclusion, I guess it really boils down to two things: EXPERIENCE and RESPECT.