Search Fund vs. Private Equity

Search Fund vs Private Equity

Search funds and private equity firms are both involved in acquiring and operating private companies, but they differ significantly in their approach, investment criteria, and objectives. In this blog post, we'll explore the key distinctions between these two investment models.

What is a Search Fund?

A search fund is an entrepreneurial investment vehicle where an individual or a team (known as "searchers") raises capital from a group of investors to acquire and operate a single privately-held company. The search fund model was pioneered at Stanford University in the 1980s and has since gained popularity as an alternative path to entrepreneurship.The search fund process typically involves the following steps:

1. Raising Capital: Searchers raise capital, typically between $400,000 and $500,000, from a group of 10-20 investors (e.g., high-net-worth individuals, family offices, or institutional investors).
2. Searching for a Target Company: With the raised capital, searchers spend 1-2 years searching for a suitable business to acquire within predetermined criteria, such as industry, size, and growth potential.
3. Acquiring the Target Company: Once a target company is identified, searchers use a combination of the raised capital and debt financing to acquire the business.
4. Operating the Acquired Company: After the acquisition, the searcher(s) assume the role of CEO or President and operate the acquired business, implementing growth strategies and driving value creation.
5. Potential Exit: After 5-7 years of operating the business, searchers may consider an exit strategy, such as selling the company to another buyer, providing returns to the initial investors.

What is Private Equity?

Private equity firms are investment firms that pool capital from various sources (e.g., pension funds, endowments, high-net-worth individuals) to acquire and restructure private companies with the goal of generating significant returns for their investors.The private equity investment process typically involves the following steps:

1. Raising a Fund: Private equity firms raise capital from limited partners (investors) to create a fund with a specific investment strategy and target size.
2. Sourcing and Acquiring Companies: The firm identifies and acquires private companies that fit their investment criteria, often using a combination of equity and debt financing.
3. Value Creation: The private equity firm works closely with the acquired company's management team to implement operational improvements, cost-cutting measures, and growth strategies to increase the company's value.
4. Exit: After a predetermined investment horizon (typically 3-7 years), the private equity firm seeks to exit the investment by selling the company to another buyer, such as a strategic acquirer or another private equity firm.

Key Differences Between Search Funds and Private Equity

While both search funds and private equity firms are involved in acquiring and operating private companies, there are several key differences:

1. Investment Focus

Search funds focus on acquiring a single company that the searcher(s) will operate and grow over an extended period (5-7 years). In contrast, private equity firms typically acquire multiple companies across various industries to build a diversified portfolio.

2. Investment Size

Search funds typically target smaller companies with enterprise values ranging from $5 million to $30 million. Private equity firms, on the other hand, often target larger companies with enterprise values ranging from $100 million to billions of dollars.

3. Management Approach

In a search fund, the searcher(s) become the CEO or President of the acquired company and are directly responsible for its management and growth. Private equity firms, however, typically rely on existing or newly hired management teams to oversee the day-to-day operations of their portfolio companies.

4. Investment Horizon

Search funds have a more flexible investment horizon, with searchers often operating the acquired business for 5-7 years or longer. Private equity firms, on the other hand, typically have a fixed investment horizon of 3-7 years, after which they must exit their investments and return capital to their limited partners.

5. Investor Involvement

Search funds typically have a smaller group of investors (10-20) who are often more actively involved in the acquired company, providing mentorship and guidance to the searcher(s). Private equity firms, in contrast, have a larger and more diverse investor base (limited partners) who are generally more passive and less involved in the day-to-day operations of the portfolio companies.

6. Acquisition Financing

Search funds often rely on a combination of the raised capital and debt financing (e.g., SBA loans) to acquire their target companies. Private equity firms, on the other hand, typically use a higher proportion of debt financing (leveraged buyouts) to acquire their portfolio companies.

7. Exit Strategies

While search funds may consider an exit strategy after 5-7 years of operating the acquired business, they are not bound by a fixed investment horizon and may choose to continue operating the company for an extended period. Private equity firms, however, are typically required to exit their investments within a predetermined timeframe to return capital to their limited partners.

Conclusion

While search funds and private equity firms share some similarities in acquiring and operating private companies, they differ significantly in their investment focus, size, management approach, investment horizon, investor involvement, acquisition financing, and exit strategies.Search funds offer an entrepreneurial path for individuals to acquire and operate a single company over an extended period, with the support and guidance of a small group of investors. Private equity firms, on the other hand, are focused on building diversified portfolios of companies, implementing operational improvements, and generating returns for their limited partners within a fixed investment horizon.Both investment models have their advantages and drawbacks, and the choice between them depends on an individual's or firm's investment objectives, risk tolerance, and entrepreneurial aspirations.