Ashley Groves recently sat down with Alex Saller of Spectra on Raise and Deploy: The International Investing to talk about Search Funds. Here are some of the key takeaways.
1. What is a search fund?
A search fund is started by someone looking to run a privately held company who doesn't have the capital themselves. They seek out companies with growth opportunities that are open to selling and then seek out investors that want to acquire a privately held company. They usually try to align company interest and revenue.
It's sometimes referred to as entrepreneurship through acquisition.
2. What do you look for in a search fund CEO?
There are many different things that you look for when evaluating a search fund CEO, but these are some of the traits and experiences we look at first.
Traits:
Passion,
Youth,
Hunger for disruption,
Growth,
Grit,
Innate capacity to lead.
Experience:
PE,
VC,
Modern tech capabilities,
Operator experience,
MBA.
3. How does a search fund work?
Search funds tend to run in two phases.
Phase 1:
The searcher goes around potential investors with a proposal that sets out the preferred type of company the fund is looking to acquire, often focussing on geography, size, and industry. However, sometimes it’s less specific.. The searcher then raises some initial capital, often around $500,000, from investors to finance the search over the course of a year. During this time, the searcher does due diligence on the market that they're going after and starts to find potential acquisition targets.
Phase 2:
The investors then have the opportunity, but not the obligation, to invest in the companies that the searcher finds. They usually hone their focus and then if the investors want in on the deal, they put up more capital to acquire the company. If the initial investors don't fill out the full round or don't opt in, the searcher is allowed to find other investors.
4. How does a search fund differ from a SPAC?
Search funds focus on small to medium size private companies. SPACs are publicly traded and often focus on much larger companies.
Search funds have become more popular in recent years because they retain benefits to being privately held, look to grow fast, get to a point of strong cashflow/EBITDA margins and then either exit or hold which all can result in strong ROIs.
5. What companies make the best targets for search funds?
Search funds are generally agnostic on industry, but they like to target companies that have some growth and some EBITDA (ideally 15%). They avoid distressed companies and like low capex companies like SaaS and services businesses.
In contrast, search funds usually avoid companies that require esoteric knowledge to run and operate, and companies in industries with few moats and lots of competitors are not as attractive. They also avoid companies with high churn and high capex companies.
6. What does the end of the search fund cycle look like?
After the searcher acquires a company and begins to operate, they usually grow and run the company for 5-7 years. A search fund usually pursues companies with positive EBITDA margins, they can receive capital back in the form of dividends or exit by acquisition. Unlike VC funds that typically push for high YoY growth and an exit, search funds have more patience so there’s less pressure to grow at any cost.
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