What are the economics of traditional searchfund vs self-funded search?
August 06, 2024
by a searcher from Universiteit Gent in Brussels, Belgium
Does somebody have a simple comparison of the economics of a transaction with searchfund, vs a transaction via a self funded search where the searcher provides part of the equity himself? I'm interested in division of the equity after 5 years, and what the benefits for the searcher are upon a potential sale after 5 years.
from Harvard University in MG9V+6H2, Guatemala City, Guatemala
Self funded:
-Using SBA loans is typically the magic here, with the ability to lever up to 90% of TEV and up to $5M with no covenants for 10 year ammortization period (no expert on SBA, so double check this). This allows you to buy a small business basically with all debt and the equity check tends to be smaller, allowing you to raise capital from low cost of equity pools (friend & family) and finance a big part of the equity yourself. As such, this allows you to set pretty aggressive economics in your favor + basically have full control of the company. The catch here is the personal guarantee you need to be comfortable with if you use an SBA loan.
-Terms for self funded deals tend to be very unique for each deal and although there are some loose rules of thumb, pretty much anything goes, as long as you find the capital to finance the acquistion
-The issue with the self funded model is when you want to go buy a larger business, where you need to raise larger amounts of dollars, where the SBA no longer is enough to acquire the business, and the only practical way to raise capital within the transaction timeframe is with larger check sizes from higher cost of capital pools, expecting self funded economics. I see time and time again self funded folks needing to raise $5M+ in equity get a rude awakening from the market of $500K+ equity check investors, when they find out that they will not invest unless you get something closer to traditional search fund terms or independent sponsor terms. Not fun when you have a deal you need to close on in weeks and you don't have the money and herding a disarrayed, heterogenous group of investors to jump on board with a moving target of a term sheet.
Traditional search fund:
-Higher cost of capital pools, but you get semi-committed capital from suposedly value add investors that could help in maximizing your chances of both successfully finding/aqcuiring a business and operating it.
-You can buy a larger business due to access to capital
-Terms are pretty much standard (25% carry for solo searchers, 30% for partnered, 1/3 at acquistion, 1/3 time vested, 1/3 performance vested) and all the governance sturcutre is set. In other words, as an entrepreneur and investor, the rules of the game a pretty much set and you decide whether or not you want to play at the time of acquisition - people under appreciate the value that has already been created by the search fund model simply by setting out the framework of the rules of the game, eliminating much of the friction that is inherent in an acquisition around terms. Yes, terms provide less control to the entrepreneur and less economics than self funded, but it facilitates fundraising and acquiring slighly larger companies.
-I don't have any study or actual statistics on this, but anectodally it seems to me that in dollar terms, tranditioanl search fund searchers end up with something similar than self funded searchers, on average - it's just how you get there that changes and therefore the important question to ask yourself is: what do I prefer, control and autonomy in a smaller biz envieronment or support and mentorship in a slighly larger biz. Pick your poison
from Indiana University, Bloomington/Indianapolis in Chicago, IL, USA
Also - in case it’s unclear, self-funded doesn’t mean you won’t have outside equity investors, it simply means you don’t take a paycheck during your search effort.
So to state it more directly, If you can afford to go the self-funded route (ie, you don’t need the salary during the period of your search effort), then It’s a no brainer to go self-funded IMO. You can see this demonstrated in the behavior of “repeat searchers” - ie no traditional searcher who has had a successful exit has ever gone back to that path - instead they go self funded when they run it back for their second go-round.
Comes down to simple math: 70-80% economics wins the day vs. 25% economics, all day every day.