Search funds offer exciting opportunities for aspiring entrepreneurs to acquire and manage their own businesses. Also known as entrepreneurship through acquisition, the term ‘search fund’ reflects the initial stage where the entrepreneur is funded to search for a pre-existing business to buy and lead. 

‘Acquisition Entrepreneurs’ or ‘Searchers’ are ambitious and entrepreneurial individuals or partners with an aspiration of business ownership. Employing an ‘entrepreneurship through acquisition’ strategy avoids the risks that come with starting a business from scratch. 

Search funds are ideal for graduates, recent MBAs, and mid-career professionals interested in business ownership. Meanwhile, investors can use search funds and equity gap investment opportunities to diversify their portfolios. 

For existing business owners considering their exit strategy, selling to a search fund can be a mutually beneficial solution. Searchers are looking to grow and nurture the business they acquire. Usually focused on only one company, and with significant personal investment through both their equity stake and time they will commit to making the company’s future a success. This is often a contrast to the private equity portfolio model where the acquired company will become one of many. In addition, it’s often necessary for Private Equity to need a new management team which is typically identified from external sources and brought in to run the business – this often precludes many small companies from being suitable PE targets. 

In this guide, we will share a comprehensive overview of search funds, including:

• What is a search fund and how do they work?
• Why is it a popular route to business ownership?
• What makes a good acquisition entrepreneur?
• What makes a good target for an acquisition entrepreneur?
• What is the search fund acquisition process?
• Finding the target and making an offer
• Funding the transaction
• The benefits and risks of investing in a search fund
• Search fund vs private equity
• Equity gap investment opportunities

What is a search fund, and how do they work? 

There are three main models for entrepreneurship through acquisition: traditional; self-funded; and single-sponsor. 

1. Traditional search funds

The traditional search fund model, originating at Stanford GSB in 1984, involves raising search capital from a group of investors to provide financial support to the searcher during the phase of identifying potential acquisition targets. This covers the salary and pre-transaction costs such as due diligence, legal fees, access to research resources, attending industry events etc. Investors serve a dual purpose of providing capital and serving as advisors, providing guidance and networking resources.  

The popularity of the Stanford model has led to generally standardised and consistent terms, allowing for a salary to be drawn by the searcher and preference shares for the investors. The searcher(s) will typically end up with c.16%-30% of the ordinary shares of the Target, depending on whether it is a solo or partnered search and how the business performs under the searchers’ leadership. 

A PPM or Private Placement Memorandum is typically required from the searcher, outlining the opportunity, identifying key industry and company features that they are targeting and a background on the searcher themselves, including the skills they bring to the process. 

With funding secured, a searcher can begin the process of identifying suitable businesses which meet their investment criteria and have future growth potential.  

As a searcher, you can expect to spend up to two or even three years identifying the right business to buy – building a network of investors, and a pipeline of potential acquisition opportunities – meeting fellow searchers, brokers and advisors to support you in the process.  

In return for supporting the initial search process, investors will receive a right of first refusal on a potential acquisition and a ‘step-up’ in the value of their search capital (usually by 50%) as it is rolled into the transaction. 

2. Self-funded searchers

Self-funded searchers navigate the first ‘search’ phase without raising search capital to fund themselves, instead investing their own time and resources in identifying potential acquisition targets.  

This structure has evolved from the traditional search model, allowing the searcher to focus on the fundraising stage once targets have been identified and retaining greater ownership and control than in the traditional model.  

Whilst a traditional search model gives the searcher the flexibility to make search their full-time commitment, self-funded searching gives the searcher more flexibility in the actual ownership and target outcomes of the acquisition process. 

This often comes at the expense of transaction size with targets often being smaller than under the traditional model. Targets are also often more likely to be stable, mature and low growth companies which are capable of supporting the debt service. The structure of a self-funded search is often more flexible than a traditional search which has become far more standardised as the model has matured.  

3. Single-sponsor search funds

Single-sponsor search involves raising capital from one investor, typically a partnership with a private equity fund or family office. The searcher usually co-invests with the sponsor once a suitable acquisition is found. There are several benefits to this model – like the traditional fund, the searchers’ costs during the search period are funded by the investor. In addition, the sponsor can regularly share resources such as transaction databases and market opportunities. 

This model may also provide more clarity over exit options, with the ability to be acquired by a fund’s portfolio company or merger with the sponsor.  

This approach requires close collaboration with the sponsor, often providing close mentorship and support – at the cost of lower integration into the wider search community. This collaboration means that the searcher often has less freedom and decision-making power regarding the acquisition that they make – the sponsor will often have significant input on the acquisition made – however this often means that the risk for the searcher is also reduced. 

Why is it a popular route to business ownership? 

For searchers

The entrepreneurship through acquisition model enables entrepreneurs to own, manage and grow an existing business. They can use their expertise to build on the existing customer base and operations, avoiding some of the perceived risks associated with start-ups, but providing the equity upside of owning a business.  

For investors

Search funds, by nature, typically prioritise sustainable growth and stable cash flows. This makes them attractive to investors and lenders by providing downside protection and the ability to diversify their investments across a wide range of businesses. Search funds also allow individual investors to exercise a more active role in the firms they invest in – lending their expertise and experience to the searcher.  

For existing business owners

Search funds provide multiple attractions to those who may be looking to retire or exit their business: 

• Often there is no suitable or willing management team to take over the role of running the business – so a search fund provides a better exit than simply winding down the company. 
• The area of the SME market in which search funds typically operate are often underserved by traditional private equity or institutional investors. The characteristics which searchers are looking for are different to those sought by private equity. Targets are often smaller – too small for the economics of a private equity fund to operate. In addition, private equity funds often need the existing management team to be retained in the business whilst search funds are looking for targets where management are looking to exit. 
• They may prioritise an acquirer who is looking to continue the company name or avoid a private equity or trade sale where employees may be made redundant and the company, which they have spent many years building, may be run in ways with which they don’t agree. 

What makes a good acquisition entrepreneur? 

A good acquisition entrepreneur typically has strong business acumen, leadership and operational skills. However, it is not necessarily essential to have all three to facilitate a successful search. The determination and willingness to learn will provide the searcher with the opportunity to build skills and experience as they work through the search and operational process.  

Often, a searcher may have a background in finance, investment, consulting or senior strategic management, but have never been able to come up with the unique business idea to satisfy their entrepreneurial drive. The opportunity to acquire an existing business gives the chance to fulfil that entrepreneurial aim and to apply the skills and experience earned in previous careers to the management of one or more companies. 

What makes a good target for an acquisition entrepreneur? 

This can vary depending on the structure of the search fund and the prior experience of the searcher. However, there are some common factors typical to each search fund structure.  

The typical characteristics of a good target opportunity include: 

• Stable earnings 
• Recurring revenues 
• Diverse customer base 
• Sustainable earnings 
• Positive cashflow to support debt service 
• Growth opportunities 
• B2B businesses with low correlation to economic cycles 
• Opportunities to make operational improvements or with new markets to enter 
• Low capital intensity 
• Simple operations 
• Fragmented industry (to facilitate a roll-up) 
• Barriers to entry 

What is the search fund acquisition process?  

There are four key stages to the search fund acquisition process:

1. Fundraising: In a traditional search fund, acquisition entrepreneurs raise capital from investors to fund the search process. 
2. Search and acquisition: This phase involves evaluating potential acquisition targets, conducting due diligence, and negotiating terms. Once a suitable target is identified, the search fund undertakes fundraising for the purchase and acquires the company. 
3.  Operation and Value Creation: The focus now is on enhancing the acquired entity’s performance and profitability. This involves introducing operational improvements, strategic initiatives, and other value-creation measures, possibly including further acquisitions. After the acquisition, searchers can then decide how they wish to run the business, either finding ways to improve operations or often utilising a buy-and-build strategy, adding further acquisitions to accelerate growth. 
4. Exit: This stage involves realising the returns for investors. Entrepreneurs can also exit the company by selling it, merging it or facilitating an initial public offering (IPO).  

Finding the target  

There are two channels for finding search acquisition targets: on-market and off-market. 

On-market opportunities

On-market targets are businesses that are openly listed for sale through channels such as business brokers, online marketplaces, or public listings. Searchers can identify on-market targets by actively searching through listings, attending industry events, networking with brokers, professional service firms, and utilising online databases and platforms such as Dealsuite (view Gerald Edelman’s unique offering with Dealsuite here), MarktoMarket, Market IQ, Captal IQ etc. which specialise in business sales. 

It is now commonplace for searchers to use interns to undertake much of the target analysis and market research. These are often current MBA students who are looking to build their experience for undertaking a search fund themselves upon graduation. Therefore, these are typically skilled individuals who can carry out detailed research and share part of the research work required to review and value a large number of targets. 

Advantages of on-market targets include: 

• having owners who are committed to the sale of their company,  
• a wide selection of available businesses,  
• more transparent pricing, and; 
• an understanding of established processes for due diligence and negotiations through their sell-side advisers.  

However, competition for on-market targets can be strong, leading to higher purchase prices and less favourable deal terms. 

Off-market targets

Off-market targets are businesses that are not openly or actively marketed for sale and require a more proactive approach to identify and engage with potential sellers. The sellers may have not considered selling their company so need time and encouragement to start the process. 

Searchers can find off-market targets through leveraging personal and professional networks, cold outreach to business owners, attending industry conferences and conducting market research to identify potential acquisition opportunities.  

Off-market targets offer the advantage of reduced competition and the potential for more favourable deal terms, as sellers are often open to negotiation and are less constrained by market dynamics. However, finding off-market targets can be challenging and time-consuming, requiring significant effort and resources to identify and establish relationships with potential sellers. 

In practice, successful search fund acquisitions often involve a combination of both on-market and off-market strategies. By casting a wide net and utilising multiple channels for sourcing acquisition targets, searchers can maximise their chances of identifying and securing suitable businesses for acquisition. Additionally, maintaining a proactive and persistent approach to networking and relationship-building can help uncover off-market opportunities that may not be readily available through traditional channels. 

Making the offer 

With a target business identified, a searcher will need to issue a Letter of Intent (LOI) and subsequently agree Heads of Terms (HoTs), at which time it is typical to enter an exclusivity clause with the sellers and kick off the due diligence process. 

HoTs commonly include: 

• Purchase price: The proposed purchase price for the acquisition often detailing the method for arriving at the valuation, along with any adjustments or considerations (e.g. working capital adjustments, cash free debt free, excess or trapped cash). 
• Payment terms: Details regarding the payment structure, including the timing and method of payment (e.g. cash, stock, earn-outs). 
• Deal structure: The proposed structure of the transaction, such as whether it will be an asset purchase or a stock purchase, and any tax implications associated with the chosen structure. 
• Due Diligence: The scope and timing of the due diligence process, including access to information, documents, and key personnel, as well as the deadline for completing due diligence. 
• Conditions precedent: Any conditions that must be satisfied before the transaction can proceed, such as regulatory approvals, financing arrangements, or completion of due diligence. 
• Exclusivity: An exclusivity period during which the seller agrees not to negotiate with other potential buyers and to negotiate exclusively with the search fund. 
• Confidentiality: Obligations regarding the confidentiality of information shared during the negotiation process and any restrictions on the use or disclosure of sensitive information. 
• Governing law and jurisdiction: The governing law and jurisdiction that will apply to the transaction documents and any disputes that may arise. 
• Termination: Circumstances under which the heads of terms may be terminated, along with any termination fees or penalties that may apply. 
• Timeline: A proposed timeline for completing the transaction, including key milestones and deadlines for each stage of the process. 

HoTs are typically non-binding but serve as a roadmap for the negotiation and drafting of the final acquisition agreement, so it’s essential for both parties to carefully review and negotiate the terms to ensure that they accurately reflect their intentions and expectations for the transaction. 

Structuring the offer 

Transaction structuring at the HoTs stage is crucial as it sets the framework for the entire transaction.  

• Clarity and alignment: the HoTs outline key deal terms, providing clarity and ensuring that all parties are aligned on the fundamental aspects of the transaction. This helps prevent misunderstandings and disagreements during later stages. 
• Illustrate commitment: HoTs demonstrate commitment from both the buyer and the seller to proceed with the transaction. It signals to stakeholders that progress is being made and encourages continued engagement. 
• Foundation for Due Diligence: The HoTs provide a foundation for conducting due diligence. They can be used to outline the parameters within which due diligence will be conducted and establish the framework for further investigation into the target company’s operations, finances, and legal status. 
• Flexibility: Although heads of terms establish the basic framework of the transaction, they also allow for flexibility in negotiations. This enables parties to refine and adjust terms as needed based on additional information uncovered during due diligence or changes in circumstances. 

Overall, structuring the transaction at the heads of terms stage is critical for laying the groundwork for a successful acquisition.  

Several factors should be considered when structuring a search fund acquisition at the heads of terms stage: 

• Purchase price and payment terms: Determine the purchase price of the target company and the payment terms, including the consideration structure (e.g. cash, deferred consideration, earn-outs) and any adjustments based on financial performance. 
• Deal structure: Decide on the overall structure of the transaction, such as whether it will be an asset or equity purchase and consider any tax implications or legal considerations associated with the chosen structure. 
• Allocation of risk and liability: Determine how risks and liabilities associated with the target company will be allocated between the buyer and the seller, including any indemnification provisions or limitations of liability. 
• Employee matters: Address any employee-related issues, such as retention agreements, severance arrangements, or changes to employee benefits and compensation.
• Integration planning: Begin discussing integration planning and post-closing arrangements, including management transitions, employee integration, and any strategic initiatives or operational changes planned for the target company. 

By carefully considering these factors and addressing them in the HoTs document, both parties can establish a clear framework for the search fund acquisition and pave the way for a successful transaction process. 

Funding the transaction

Once the initial search has been completed and a suitable target identified, the acquisition funding is the next stage in the process. Capital for the transaction often comes from multiple sources: 

Equity financing

In a traditional search structure, equity financing for the acquisition will often come from the same investors who supported the initial search process. In exchange for their investment in the search capital, investors receive equity ownership in the search fund entity, which roll into the transaction if/when one is found, usually with a ‘step up’ of 50%. They will also often ‘follow-on’ with a pro-rata investment of the equity required for the acquisition. 

In addition, new investors may be sought if more equity is needed than can be raised from the initial investors. 

For self-funded searchers, this is where getting backing from investors begins. It often helps to have built a network of potential investors prior to this stage in order to provide more confidence in achieving a successful fundraise, giving more certainty to the sellers and speeding up the transaction process which in itself will reduce the risks of the transaction not completing. 

Investors may include high-net-worth individuals, family offices, venture capital firms, private equity investors, or other institutional investors. 

Debt financing

• Debt financing may involve obtaining loans from banks or alternative lenders and may come in a variety of formats. Common types of debt financing include term loans, lines of credit, asset-based financing, government-backed loans or hybrid debt and equity arrangements. For businesses with capital found on their balance sheet, an asset-based lending facility can unlock that value to provide the funding to support the acquisition process. 
• Cashflow lending – loan size is determined by a multiple of EBITDA with repayments made from the future cashflows of the business. 
• Searchers may also explore financing options offered by government agencies or development finance institutions, such as the British Business Bank or regional development funds. 

Vendor financing

Seller financing is a common element in search fund acquisitions. Here, the seller of the business provides some of the funding for the purchase. Seller financing terms may include deferred payments, earn-outs, or instalment payments based on the future performance of the business. Seller financing arrangements can help bridge any financing gaps and demonstrate the seller’s confidence in the business. 

Equity rollover

Equity rollovers may form part of the funding, where the seller or existing management team retains an equity stake in the business post-acquisition. 

Equity rollovers align the interests of the seller or management with those of the new owners and can provide continuity and stability during the transition process. 

Regulatory considerations

Search fund transactions in the UK are subject to various regulatory considerations, including securities regulations, taxation law, and compliance requirements. 

It’s essential for searchers and investors to seek guidance from legal and financial advisors to ensure compliance with applicable laws and regulations throughout the transaction process. 

By leveraging a combination of equity and debt financing, along with potential seller financing and equity rollovers, UK-based search fund transactions enable searchers to pursue acquisitions while mitigating risk and maximising returns for investors. Working closely with experienced professionals can help navigate the complexities of financing and regulatory requirements in the UK market. 

The benefits of investing in a search fund 

For investors, search funds can represent an attractive investment class for multiple reasons:   

• Returns – the returns achieved across multiple surveys have shown above average performance. In a 2020 study by Stanford University, they found that the ROI for all known investments was 5.5x with aggregate IRR of 32.6%. In addition, a 2022 CES analysis of 526 qualifying search funds found the aggregate pre-tax internal rate of return to be 35.3%, and the aggregate pre-tax return on invested capital to be 5.2x. 
• Investor input – there is an opportunity to provide mentorship and guidance to the searcher throughout the search, acquisition and operating phases. This allows for more input and the potential for more successful outcomes, particularly if the investor has industry or operational experience. This guidance can prove to be invaluable for the searcher and can provide non-financial rewards to the investor. 
• Limited initial investment – investing in a traditional search fund is done in stages. The initial purchase of a unit (or units) in a search fund does not commit the investor to contribute further capital for the acquisition funding, although it does provide the optionality to do so. In addition, there is the opportunity to better understand the searchers during the search process and analyse the investment opportunity provided in the second round with significantly more information. By being an investor in the search phase, investors receive a ‘step up’ of usually 50% into the equity at the time of the acquisition. There are often benefits of preferential rights, with option value of the initial investment. 
• Acquire an established SME as opposed to investing in venture capital opportunities where the odds of failure are high. 
• The searcher is usually a talented and driven individual who has the energy and commitment to make a success of the investment opportunity. The searcher also often has a large amount of ‘skin in the game’ to make sure that the company becomes a success. 
• Diversification – as the average investment size is small, it is possible to spread this across multiple opportunities. These in turn can be focused on a variety of different sectors to increase the diversification, or focused in certain areas to benefit from the experience of the investor and their ability to appraise opportunities. 

Whilst there are many benefits to investing in search funds, like all investment classes, there are risks:  

• Inexperienced searchers – Many searchers have little or no experience in acquiring companies so there is a danger of the search phase going unsuccessfully, using all of the search capital without finding a suitable acquisition target.  
• Minimal operating experience – Searchers often have little or no experience of managing and operating a company on a day-to-day basis and dealing with the myriad of complexities that come with having responsibility for all areas of a business.  
• No secondary market – Exit opportunities can be limited, particularly if the acquired company performance is below expectations.  

Those investors who participate in the initial round of equity financing will buy investment units in the fund and receive:   

• Pro-rata right of first refusal to invest additional capital in the acquisition. Investors will have the right but not the obligation to participate further in financing the acquisition.    
• ‘Step-up’ in the acquisition for the target company. Investors who take the risk of investing in the initial round of financing (search capital) typically receive a carried interest in the acquired company. This carried interest is usually equal to their share of the search capital multiplied by a step-up multiplier (e.g. 1.5x). This premium is awarded regardless of their participation in the target acquisition round. 

Search fund risks 

A search fund’s success depends on the searcher’s ability to identify, acquire and run a profitable business. Whilst an exciting opportunity, searching for and identifying a target business is also time-consuming and uncertain. There’s also the financial risk – there is no guarantee an acquisition will be completed at the end of the process.   

In a traditional search fund, the initial search capital is highly speculative, which is compensated by the step up in equity on acquisition. 

For a self-funded search, the searcher is investing – and hence risking – their time and personal resources to finance and undertake the search process. 

Search fund vs private equity 

While both search funds and private equity firms target established businesses, their approaches diverge significantly. Search funds embody a hands-on entrepreneurial spirit. They raise capital to identify and take the operational helm of a single company. This focus enables the searcher to deeply integrate their expertise and drive growth within the acquired business. While roll-up or serial acquisition strategies might exist within the entrepreneurship through acquisition umbrella, the core remains an operator-centric model. 

In contrast, private equity firms function on a much grander scale. They manage diversified portfolios, encompassing multiple businesses across various industries. This portfolio approach allows them to spread risk and capitalise on opportunities across a broader spectrum. While PE firms may influence acquired companies through board representation, their primary focus lies in strategic financial management, not day-to-day operations. 

Search fund

• Launched by an Acquisition Entrepreneur/Searcher to search, identify, acquire and run a business. 
• The aim is often to buy a single company that an entrepreneur can operate for the medium to long-term. 
• Often look to replace senior management and undertake operations themselves. 
• Not required to return capital to investors within a specified period. 
• Typically buys small to medium-sized companies. 
• Relies on the financial backing of at least one individual investor. 
• Targets established businesses with stable market share and cash generation to support debt servicing. 
• Investment capital comes from private investors. 

 Private equity

• Encompasses a broad range of investment strategies. 
• Managed by professional investment firms that handle pooled capital. 
• Must return capital to its investors within a specified timeframe. 
• May involve several approaches, such as leveraged buyouts, growth capital, and venture capital. 
• Typically follows a portfolio strategy, investing in many companies at once. 
• External professional operators are hired to run the business. 
• Targets companies at different stages of development, from start-ups to long-established businesses. 
• Transaction sizes are typically larger to ensure that returns are sizeable enough to cover the cost base of operations. 

Equity gap investment opportunities 

Self-funded searchers and traditional search funds who are unable to raise all their required equity from their incumbent investors end up with what is known as an ‘equity gap’. This is a requirement for equity funding that outweighs the commitments they have already received. 

In these situations, the searcher must take the opportunity to the market to source investment to fill the gap under the same terms as those committed to by the existing investors. Opportunities exist here for investors who do not have the appetite to invest in the speculative search capital but nevertheless want to invest in SMEs being led by acquisition entrepreneurs. 

There are several crucial things to be aware of before proceeding with a search fund acquisition. 

Historical earnings 

As a searcher, you may need a bank loan to part-fund an acquisition. It’s standard practice for banks to ask you to conduct formal due diligence on the business’s earnings. You’ll need an in-depth understanding of the business’s underlying or adjusted earnings and this will need to be verified by a third-party professional before being presented to the bank. 

Forecast earnings 

As well as historic earnings, it is key to understand the future maintainable earnings of the business to ensure there are sufficient funds to service debt and be confident about the future performance. When reviewing potential search fund targets, look for realistic and well-supported projections that align with industry trends. Scrutinise the assumptions and methodologies used in creating these forecasts and carry out scenario analysis to understand and plan for the worst-case scenarios. Rigorous due diligence here will help mitigate potential risks. It will also provide a more accurate picture of potential profitability and growth. 

Working capital 

Cash generation is key to the search fund model so understanding working capital during due diligence goes hand in hand with this. It helps provide critical insights into the financial health and operational efficiency of the target company. By understanding the components of working capital, the searcher can gain a comprehensive understanding of the company’s liquidity, cash flow generation and short-term financial obligations.  

This is essential for assessing the adequacy of working capital to support ongoing operations, identify potential red flags such as cash flow constraints or excessive inventory levels, and formulate strategies for post-acquisition integration and optimisation. Understanding this will allow you to negotiate favourable terms, mitigate financial risks, and ultimately enhance the likelihood of a successful transaction. 

Tax and contingent liability risks 

When buying a business, you’re often acquiring everything within the company. This can mean its past and present liabilities. A thorough legal, tax and financial due diligence process will help to ensure you understand what you’re purchasing. It checks the company complies with all relevant tax laws and any current legal issues or claims. You’ll identify the business’s commitments and obligations, such as leases and loans. 

Other due diligence 

Due diligence is essential to the search fund process. It ensures you understand what you’re committing to. You’ll be able to identify and mitigate potential risks and meet investor requirements.  

How Gerald Edelman can help 

At Gerald Edelman, we provide tailored advice for every stage of the search fund process. With our expertise in accounting, taxation, due diligence and financial planning, you can make informed decisions. Contact us today to find out more. 

For a deeper exploration of Search Funds, explore the following resources: 

• Buy and Build: Financial Due Diligence Best Practices 
• M&A Talk: What Sellers Should Know About Selling Their Business to a Search Fund 
• Multiply Your Success with Tom Dufore: Entrepreneurship Through Acquisition with Carl Lundberg 
• Making Billions with Ryan Miller: Search Funds: The Secret to Launching Companies that Win