How aspiring young CEOs tap into “search funds” to acquire companies they can run

The latest breed of young MBA graduates is opting for a quicker path to manifest their dream of becoming owner-CEOs. Instead of building a startup from scratch, these newly minted MBAs are tapping into the “search fund” model to solicit funds to search for privately owned businesses to acquire and lead.

Data from Stanford’s Graduate School of Business reflect the growing popularity of search funds. The school’s preliminary numbers for 2020 show 70 Stanford graduates started search funds, potentially besting the all-time high of 51 graduates in 2019. The program estimates that even more were launched in 2021. 

Understanding “search funds”

By definition, a search fund is an investment vehicle through which investors provide financial support to an entrepreneur’s efforts to locate, acquire, manage and run a privately held business. In other words, they give aspiring CEOs a fast path to managing a company in which they also have a meaningful ownership position.

How it works: An aspiring CEO scouts for a privately held under-the-radar company they can acquire and run. The searcher raises initial capital from investors to fund the search and later seeks additional capital for the acquisition upon finding a suitable target. Post-acquisition, the searcher takes over as CEO and runs the company for the medium to long term, eventually exiting.

How is it catching on: The search fund model isn’t new. It was conceived in 1984 but has recently taken off anew at business schools. Out of more than 400 search funds raised since 1984, half were within the past several years. A record 88 search funds were launched in 2018 and 2019, according to Stanford’s 2020 Search Fund Study. Around $1.4 billion of equity capital was invested in traditional search funds and acquired companies from 1984 through 2019, the study finds.

How’s the ROI? The financial returns from search funds have been good enough to entice investors. The Stanford study found that of the more than 400 search funds raised, three-quarters of businesses acquired by searchers yielded a positive return for investors — wherein 69% of firms delivered at least double the return on investment. Overall, the pre-tax return on invested capital was found to be 5.5x, with a pre-tax internal rate of return of 32.6%. 

But there are risks too

The financial outcomes of search funds are certainly impressive, but this path can be challenging and sometimes dicey. 

Young searchers may miss out on campus recruiting events for jobs with big names in Silicon Valley, at Fortune 500 companies or on Wall Street.

As searchers do not target flashy startups or popular brands but smaller and lesser-known companies that don’t attract typical investors, finding one isn’t easy. Identifying an appropriate business entails countless cold calls to potential sellers and many rejections. 

Last but not least, not all searchers end up with success. According to the U.C. Berkeley Haas School of Business, about one-third of all searches conclude without making an acquisition. 

Boy’s club?

The search fund community is no exception to the gender gap. Data from Stanford’s search fund study indicates a sharp underrepresentation of women in search funds, with women accounting for only 7% of individuals that began searching in 2018 or 2019. Note that the latter were years that registered a record number of search funds launched and acquisitions.

Takeaway:

Though a growing number of MBA graduates are getting in on the action, the search fund model isn’t for everyone. For those with true startup aspirations and love for the entrepreneurial process, this path might not be the right fit.