13 JUL, 2022
By Javier Puig
The Search Fund model has been active in the US for over 35 years. As a pioneer country, the ecosystem in this geography has developed enormously over the last few years and there are already several specialised funds of more than €200M AUM.
In Europe, this model is more recent and innovative, yet the Search Fund ecosystem is growing enormously and showing exceptional results. Spain is the country in Europe with the largest number of Search Funds and investors.
The Search Fund model is an entrepreneurial route where one or two entrepreneurs (also known as Searchers) create an investment vehicle called a Search Fund, with the objective of raising capital from a number of investors to finance the search for one SME in order to acquire, operate and grow it.
Instead of starting a company from scratch, in this case the entrepreneurs seek to continue the fundamental pillars of the acquired company's success. Entrepreneurs build on the legacy of the company's founder with the help and advice of their investors, seeking to materialise a new phase of growth for the SME.
The target company of the Search Fund is an SME with an EBITDA between EUR 1,000,000 and EUR 3,000,000. They look for solvent companies with a good financial structure. Companies with a history of profitability and growth, which, due to succession problems or other reasons, their owners want to sell. These are companies that tend to be below the natural targets of private equity funds and above the targets of venture capital funds. Search funds are therefore an alternative for many busines owners who want to sell their companies.
For years, Stanford University has been conducting a biannual study of the ecosystem and, based on the nearly 400 search funds analysed, the historical average IRR of this type of vehicle is 32.5%. IESE produces a similar study which includes all non-US based Search Funds, in this case the historical average return is 28.5%.
The key to historically high returns is the high level of preparation of the entrepreneurs and the collaborative nature of the model, where the Searcher is supported by its investors during the search for the business to be acquired and during the management of the acquired company.
The acquisition of the company is made between 10-12 investors who analyse the investment opportunity independently, thus validating the growth and value creation potential of the SME to be acquired. From the group of investors who decide to participate in the acquisition, a highly qualified management committee will be selected to assist Searcher in value creation and growth over the coming years.
Another key aspect of the success of the Search Fund model is the alignment of interests between investors and Searchers. Through an effective incentive system, the entrepreneurs can obtain up to 25%-30% of the company's equity depending on the return obtained by the investors at the exit. The entrepreneurs, and now the new management, would thus become the most relevant shareholders of the company, and in this way the objectives of the Search Fund/ management and the investors would be 100% aligned.
The profiles of the Searchers are very different, some with more management and operational skills, others with better financial knowledge. The vast majority have more than 10 years' experience and an MBA from a prestigious business school, as this is where many of these entrepreneurs get familiar with the Search Fund model. Stanford in the US and IESE in Europe are two business schools that have been helping and raising awareness of the Search Fund model for a long time.
Apart from economic factors, the main reason why young entrepreneurs with such outstanding profiles decide to change their professional careers and start managing their own business through an acquisition is because they see the beauty of the Search Fund model: finding and acquiring a company by raising capital from highly experienced investors, and then managing this unique company on a day-to-day basis while creating value and generating growth. It is such a complete process that it is not surprising that it attracts many highly skilled entrepreneurs. As a common denominator, all Searchers have a vocation for management and leadership, they are eager to take the reins of a stable company and take it with the help of their investors to the next level.
High historical returns are one of the reasons for the proliferation of this type of alternative investment vehicles, but not the only one. Investing in Search Funds helps and encourages highly qualified entrepreneurs and strengthens the economy by encouraging the growth of a wide range of SMEs.
The search fund model is proliferating around the world, which has led to the emergence of specialised institutional funds such as Arada Capital Partners. After the baby-boom generation, simple demographic reasoning makes it clear that the opportunities for acquiring companies/SMEs are very high.
Arada Capital Partners, has access to a niche market between VC and PE with very good investment opportunities, allowing it to diversify its investment both by sector and geography, investing in solid and profitable SMEs, located and managed through Search Funds.
Undoubtedly, as was the case a few years ago with Venture Capital, the concept of the Search Fund is here to stay.
By Christian Rom