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Search Fund Process and Best Practices


From my last post about search funds, I took a closer look at some of the documents on the Stanford CES website.  Specifically, I read through a 2007 study on the state of search funds.  It covered the stages search funds go through and typical characteristics at each stage - profiles of principals, typical fund and acquisition sizes, range of returns for the funds, etc.

Some highlights from the four stages of search funds are as follows:
  1. Raising the search fund (3 months): Write a formal proposal and business plan for the fund.  Sections of the plan include - executive summary, overview of process, list of screening criteria, detailed timeline and milestones, explanation of financing sought, outline of exit alternatives, backgrounds of principals and allocation of future responsibilities in the target.  Raising a fund typically takes around 3 months.
  2. Identifying and making the acquisition (20 months): The three steps in identifying an acquisition are 1) generating deal flow, screening potential candidates, and assessing seller interest.  Typically, principals focus on only a few (2 - 4) target industries and may even further limit their search geographically.  This is a very time-consuming process.  A thoughtful industry screen can take between four and eight months of full-time effort (a lot of effort) and may not turn up a potential acquisition.  Companies are targeted within those industries based on "sustainable market position, their history of positive, stable cash flows, and opportunities for improvement and growth".  This criteria limits the risk associated with investing in principals that have little experience running companies.  Purchase prices range from $5 - $20 million (at around 0.9x annual revenue or 4.9x EBITDA).
  3. Operation (2 - 5 years): Principals run the company for 2 - 5 years focusing on growing the value of the business.  Value creation can happen through multiple ways: revenue growth, improvements in operating efficiency, appropriate use of leverage, or expansion.
  4. Exit: Liquidity events occur in multiple ways, including: sell, take public, investor equity may be sold to other investors or bought back by the company, or dividends may be issued.
Typical search funders are around 30 years old, recent MBA graduates, and ex-management consultants or investment bankers.

I also came across a good best practices document titled "Management Principles for MBA Search Fund/LBO Executives".  It sounded like the biggest risk factor of the business are the people - the old team, the new team, and coaching resources.

Managing Performance of the Old Team: The new CEO has to take control immediately and hold his new employees accountable for their performance.  It's a common mistake for CEO's to let performance issues slide.  This undermines the principal's credibility with employees and jeapordizes the company's ability to perform at the required level.

Getting New Team On-Board Quickly: The new CEO also needs to get their new management team established as soon as possible so that they are running the business (instead of the other way around).

Coaching: The principal should also not feel shy about leveraging the experience of the new board of directors.  Investors expect the new CEO to need support, so it's not a bad idea to have a board member on retainer during the first few months of transition.

Some additional resources to look into further:
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