REFRAMING THE SEARCH MODEL
I wrote this essay a few weeks ago on twitter, I thought it was relevant for the forum, interested to hear your thoughts:
Search funds are LBO acquisitions, done by recently graduated MBA’s. Investors give them funds to pay their “Search” a[redacted]months process to acquire and run a small, healthy business. I attended my first search fund conference in 2016 at IESE in Barcelona. I was a startup entrepreneur curious about the system.
I came away feeling like the search model was interesting, but the structure and incentives didn’t make sense. I understood that recent MBA graduates were foregoing larger salaries, and they had debt. I understood the historical returns search funds generated (so who am I to question it?), but I left with a few doubts:
1. Why searchers gave up so much potential equity to receive a 24-month salary? The searcher would still be taking on financial risk (personal guarantee), and operational risks post-close. 2. After speaking to a few failed searchers, I felt the investors and searchers were fixated on finding the perfect deal. Both searchers and investors killed deals because it didn’t tick every box.
After starting two companies, I think the ETA model is the most de-risked starting point for an entrepreneur. However, I feel the independent sponsor model offers the best alignment for investors and entrepreneurs. The investors get a fully vetted company, with a motivated operator. The entrepreneur is compensated for their risk with a majority equity share.
In LMM acquisitions all deals have warts. I believe the search fund should be reframed as the first step in creating a larger holding, or fund. Focusing on the perfect deal keeps the entrepreneurs out of the arena. Once you are an owner, finding attractive acquisitions is far easier.