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Search funds are vehicles for entrepreneurs to raise funds from investors interested in making private equity investments. Most importantly, they provide capital access for promising managers to become entrepreneurs through acquisition.
In the first stage, a small group of investors back operating managers to search for a target company to acquire. A fund may or may not find a target acquisition company. Investors are able to invest a pro-rata share in the target company, subject to their individual liking. In the second stage, the general managers of the search fund take operating roles in the acquired company, such as CEO and President.
Search funds typically target companies in the $5 million to $30 million price range, requiring $2 million to $10 million of equity capital, in fragmented industries, with sustainable market positions, histories of stable cash flows, and long term opportunities for improvement and growth. Service and light manufacturing companies outside high tech industries are popular targets. Often these companies are under-managed prior to the acquisition.
Most search funds are started by entrepreneurs with limited operational experience and possibly no direct experience in the target industry. The goal of the investor is to place promising, motivated managers in an environment with a high probability for success given the oversight and experience of the investors themselves.
The origins of the search fund are often traced back to H. Irving Grousbeck, a professor at Stanford University's Graduate School of Business, who originated the concept in 1984. Since then, it is estimated that 627 traditional funds have been or are currently being formed, with 198 operating currently. The bulk of successful search funds have been raised by alumni of elite MBA programs with access to strong private equity networks. Stanford University has documented more than 177 search funds.
Two annual conferences, hosted by The University of Chicago, Northwestern University, and Harvard Business School bring together search fund entrepreneurs, investors, MBA students, and others to network, share learnings and partner in this space.