What is a Search Fund?

Fundamentals of a Search Fund

A Search Fund is an investment vehicle that enables one or two entrepreneurs to search for, acquire, and operate one private, profitable small-to-medium sized business (SME).

Terminology

As with most asset classes in finance, it is important to clarify some jargon to avoid any confusion further down the line:

A Searcher is an entrepreneur seeking to acquire and run an SME.
A Search Fund is not actually a fund but simply the investment vehicle used by the Searcher.
Search Capital is the capital required by the Searcher to cover operational expenses (e.g., salary, travel expenses, set-up costs, intern salaries, office space, due diligence costs, etc.) required to complete the search period up to 24 months.
Acquisition Capital is the capital required at acquisition. Investors can roll in their invested Search Capital into the Acquisition Capital plus a 50% step-up.
A Unit is a portion of the Search Capital held by investors.

How it works

There are 3 key steps in the life cycle of a Search Fund.

1. Search for and acquire a company

After having raised Search Capital from a group of investors and having set up their Search Fund, Searchers gather company information and select companies based on a series of criteria including but not limited to:

Enterprise value: €5-40m
Minimum 15% EBITDA margins
Strong quality of revenue (contractually recurring)
Clear seller motivation (usually retirement and lack of successors)

Based on their selection, Searchers put together a list of companies and then contact the company owners to gauge interest to sell via email, letters, calls, and in-person meetings. Searchers contact thousands of company owners over a period of up to 24 months. Once they have identified a high-quality target and after a few exchanges with the business owner, they will enter into an agreement known as a Letter of Intent (LOI) expressing both parties’ intent to enter into a sale agreement, setting out basic terms, and granting Searchers with exclusivity.

Once the LOI is signed, Searchers will run three workstreams in parallel: (a) due diligence, (b) structure financing, and (c) managing the seller.

(a) Due diligence: Searchers will dig deeper into the business and conduct due diligence ranging from commercial, financial, fiscal, legal, and industry-specific technical diligence wherever required. Searchers will engage professional service providers such as lawyers, accountants, and financial advisors to assist with the diligence process. Searchers must ensure that they fully understand the business and industry and have fully evaluated any issues that may arise to assess whether the business is a good target, how to best value it, and how to best run it after the acquisition.

(b) Financing: Searchers regularly need to communicate with their investors to gauge their interest in the target as well as build relationships with lenders to finance the rest of the transaction. Searchers must evaluate how to best structure the transaction with a mixture of equity, bank financing, and seller notes and/or earn-outs.

(c) Seller management: The reality is that taking over a business from a seller is an emotional journey for the aspiring entrepreneur, but even more so for the seller who is selling his/her life’s work. It is likely that a seller does not have any prior transactional experience and therefore it is the Searcher’s job to guide a seller through the process. Equally, it is important for Searchers to foster a cooperative and strong relationship with the seller as the seller may stay on as a consultant or may be tied to the company through incentive schemes. Therefore, sellers can act as a powerful ally and helpful tool when operating a business in an often-niche industry.

2. Operation and value creation

Running a business is the Searcher’s ultimate goal. Once Searchers have completed the acquisition, they will spend the next four to seven years running the business, leading employees, and creating value. Searchers are guided by a board of directors that coaches and supports them as they grow as CEOs. Typically, Searchers do not make any radical changes to the business and instead focus on getting to know the business and their new role for the first 100 days. After gaining familiarity and understanding, Searchers might implement some changes and grow the business to create value.

3. Exit

Once Searchers implement their value-creating strategies for a couple of years and grow the business, an opportunity to exit may arise. Such an exit could be in the form of a direct sale of the company to a strategic buyer or a larger private equity fund, a public offering, or an alternative liquidity event.

Key terms

Right of first refusal: Investors have the option, but not the obligation, to participate in financing the acquisition.
Step-up: Every Unit will be increased by 50%, meaning that for every €1.00 invested, investors will receive €1.50 either rolled into the acquisition or in cash, should they decide not to participate in the acquisition. This 50% step-up serves as compensation for the investors’ increased risk of investing in the Search Capital.
Vesting schedule: The Searcher will earn a share of the common equity in return for identifying, acquiring and operating the target company. The Searcher will have the opportunity to earn up to 25% of the common equity (30% for duo Searchers). One third vests at acquisition, another third vests over time at the four-year mark post-acquisition, and the final third vesting is subject to performance goals (full vesting upon achieving a 35% IRR). This mechanism highlights the alignment of interest between Searchers and investors.

Who are the key stakeholders?

Searcher

A Searcher is an individual, often with a background in business, who decides they want to own and manage a company rather than start one from scratch. However, buying a business requires money and expertise, which they may not have on their own.

This model provides a Searcher with an entrepreneurial opportunity to own and run their own business. Not only does this model democratize entrepreneurship through acquisition by providing capital to aspiring entrepreneurs who may not have access to capital to conduct a full-time search, but it also provides mentorship with investors who are actively involved in an entrepreneur’s search journey. Additionally, the vesting of equity provides a financial incentive – this is where a generational wealth is created without having to set up a business from scratch.

Seller

In a Search Fund transaction, a seller typically wishes to retire but does not have a clear succession plan. Seller motivations could include nearing retirement age and wishing to focus time more on personal matters.

The Search Fund model provides sellers with a clear succession solution while preserving their legacy. A sale is often more than a typical buyout, a Searcher becomes akin to a child taking over the family business. Finally, the sale provides a seller with liquidity.

Investor

Searchers will build their capitalization table with a mixture of different investors: friends and family, local investors, and primarily institutional investors dedicated to Search Fund investing, such as Innesto Partners. Friends and family help kick off the fundraising campaign with early commitments, local investors help Searchers with introductions to local businesses and sharing local industry knowledge, and institutional investors provide comprehensive support and mentorship from search through exit. Dedicated institutional Search Fund investors are uniquely positioned to support Searchers to seek and identify the right target, guide them through the acquisition process, and support them as board members or lead investors through the operational phase as well as the exit.

Investors and Searchers are aligned in the economics of the acquisition and in their shared entrepreneurial goal. In short, a Search Fund is like a steppingstone for entrepreneurs to achieve their dream of owning and growing a business, while also benefiting investors and the original owner. It’s a win-win-win model.

History of Search Funds

The concept was founded at Harvard Business School in 1984 by H. Irving Grousbeck, who introduced the concept as an alternative career path for MBA candidates who wish to become entrepreneurs without starting a business from scratch or having the means to do so.

The model grew in the United States and proved successful with increasing numbers of universities teaching classes about the asset class to highlight Search Funds as a viable path to entrepreneurship. Around the 2010s, the Search Fund model expanded beyond the United States with Searchers emerging in Canada, Europe, Latin America and Asia. The Graduate Stanford Business School partnered up with IESE Business School in Spain to produce a paper setting out trends and observations around Search Funds every two years, which further increased international expansion to Spain and Europe more broadly. To date, over 900 Search Funds have been raised worldwide. A 2024 study conducted by Stanford Graduate School of Business concluded that a portfolio of first-time Search Funds in North America produces average returns of 35% internal rate of return and 4.5x multiple on invested capital.

Key resources

For those looking to deepen their understanding of Search Funds, a wealth of resources is available, ranging from books and academic research to podcasts and online platforms. Whether you're an aspiring searcher, an investor, or simply curious about this unique investment model, these materials provide valuable insights into the process, challenges, and success stories of search funds. Below is a curated list of essential resources.

1. Books

- HBR Guide to Buying a Small Business – Profs. Richard S. Ruback & Royce Yudkoff
  - A foundational guide to Search Funds and a practical manual from Harvard Business Review covering everything a Searcher needs to know about buying and operating a small business.
- Buy then Build – Walker Deibel
  - A book covering a step-by-step guide to acquiring small businesses and growing them.

2. Academic papers & Research

Search Fund Primer – Stanford Graduate Business School
- Stanford’s introductory guide for those new to the Search Fund model.
2024 Study – Stanford Graduate Business School
- The most authoritative research on Search Funds, tracking performance data and trends in the US and Canada.
IESE Publications
- The International Search Fund Center offering a summary of key industry observations every two years covering the rest of the world (ex-US/Canada) and other targeted academic papers.
Innesto Partners Resources
- Innesto’s hub covering a wide range of articles, interviews with Searchers and other academic papers.

3. Podcasts

Think Big, Buy Small – Profs. Richard S. Ruback & Royce Yudkoff
- Podcast with Harvard Business School Professors where they discuss various trends and observations around Search Funds.
ETA Insider Podcast – Polsky Center for Entrepreneurship and Innovation
- Podcast with various hosts to discuss any topics related to entrepreneurship through acquisition.

4. Platforms

Women Search Network – A platform supporting women in search with resources (including a podcast, articles and events), leadership teams covering all geographies, and access to WhatsApp groups to connect with other women in the space.
Searchfunder.com – A dedicated online community for Search Fund entrepreneurs, investors, and advisors.

Search Fund conferences are a great place to meet fellow Searchers, investors and other players in the space. An article on conferences will follow – stay tuned!

Introduction to Innesto

Innesto Partners is a fund dedicated to Search Fund investing with a focus on Europe, but also opportunistically in North America. Our team has a complementary skillset covering searching, investing, operating, and legal experience. We are dedicated to support Searchers throughout their entire entrepreneurial journey.

Thinking of launching a Search Fund?

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