A typical path to the pinnacle of business is to climb the corporate ladder to an executive position or create a startup company. Both options carry their own set of opportunities and risks. In recent years, another career route with a direct path to business leadership, known as a search fund, has grown in popularity. 

What is a search fund? 

A search fund is an investment vehicle through which a small group of investors search for, acquire, and operate a privately held company for the medium to long term.¹ 

How is a search fund different than traditional private equity? 

There are a variety of similarities and differences between a search fund and traditional private equity, with the main difference being post-acquisition operations. A search fund is founded by an individual or team who will operate the acquired business as management throughout the investment horizon. Traditional private equity serves as a financial sponsor of an investment in a business and requires an operational management team for each investment. Additional differences between a search fund and traditional private equity include: 

What is the lifecycle of a search fund? 

The search fund lifecycle and typical timelines can be broken down into the four stages shown in Figure 1. 

Figure 1: The search fund lifecycle Source: Kelly, Peter, and Sara Heston. 2022 Search Fund Study: Selected Observations. Case E-807. Stanford Graduate School of Business, 2022. 

Stage 1: Raise initial capital 

A search fund raises capital via a private placement memorandum, developed under experienced legal counsel's guidance. Engaging qualified legal counsel is crucial to ensure compliance with laws and regulations and optimize the legal and tax structure. 

Search funds typically raise capital in two tranches: 

1. Search capital: Used to fund expenses, including searcher compensation and due diligence costs, during the search for an acquisition target. In exchange for investing in the search capital tranche, investors will typically receive: 

• The right, with no obligation, to invest in the acquisition capital tranche to consummate an acquisition 
• Conversion of search capital into securities issued as acquisition capital, typically on a stepped-up basis 

2. Acquisition capital: Used to close on the acquisition of a target company 

Most search fund principals solicit investors with relevant skill sets who can be engaged as advisors. An ideal investor for a search fund can assist with the evaluation and execution of transactions, contribute to business management, and provide leverage with lenders, lawyers, and other service providers. 

Stage 2: Search for & acquire company 

The search and acquisition stage is typically more time consuming than raising initial capital and can get sidetracked due to unwilling sellers, regulatory issues, or complicated transaction execution. Successful searchers will normally employ a systemized process to generate deal flow and analyze opportunities in a way that allows them to quickly accept or reject opportunities before investing significant resources. 

Search funds typically target stable and fragmented industries where acquisition targets can be evaluated on their sustainable market position and historical operating performance. The ideal target will have a history of stable operations, positive cash flow, and potential for growth. 

When an acquisition occurs, the acquisition capital raised in stage 1 of the search fund lifecycle will be combined with additional financings, such as vendor debt, bank debt, additional equity, or earnouts. The capital structure of closed searches can vary significantly by industry and capital market environment at closing. 

Stage 3: Operate & create value 

Once a company is acquired, the search fund principals manage day-to-day operations. Search funds rarely pursue turnaround targets, which frequently results in little to no significant business changes in the first two years post-acquisition as new management focuses on becoming familiar with the existing inner workings of the business.² Once searchers are familiar with current operations, value is typically created by increasing revenue, margins, and efficiency; optimizing leverage; adding bolt-on acquisitions; or expanding. 

Searchers are commonly paid an annual salary and bonus but are heavily incentivized through a carried interest in the investment, which aligns their efforts to create value quickly in hopes of realizing increased equity value through an executed exit. 

Stage 4: Exit 

Even though search funds operate under longer-term horizons than other investments, investors will focus on achieving an exit. Principals of the search fund will constantly evaluate exit options while running the business, looking for an ideal time to realize maximum value. Liquidity events can take many forms, including selling to a public company, going public, repaying investor debt, recapitalizing existing investor equity, or selling to another private company or investor. 

What returns do search funds generate? 

Measuring general search fund returns is a nearly impossible task, as the funds are private with no published benchmark index. When measuring returns, there will be a difference in returns for exited funds compared to operating funds. To further complicate the situation, some search funds may never progress beyond the search phase and never acquire a company, resulting in a further drag on returns. 

A study of search fund returns by the Stanford Graduate School of Business reports that, since 1984, 66 percent of searches have resulted in acquisition, and 73 percent of those resulted in a positive return. The same study reports that exited search funds received an average internal rate of return of 36.8 percent.³ 

Does a CFA charterholder have the skills to execute a search fund? 

The CFA Program equips candidates with expertise and real-world skills in investment analysis. The skills gained from the CFA Program will help a prospective searcher with fund inception, study of potential acquisition targets, and execution of the acquisition and disposition transaction. Depending on the industry and company acquired, there may be a skills gap in day-to-day business operations, but this can be overcome by stepping into existing processes. A significant benefit of search funds and acquisition entrepreneurship compared to typical startups is that the searcher is acquiring an established operating business with existing cash flow, customers, employees, product-market fit, and pricing. This allows acquirers to hedge downside risk while maintaining upside through carried interest if they can create value for investors. 

² Kelly and Heston.

³ Kelly and Heston.