Returning Excess Search Capital to Initial Investors

by a searcher from Carleton College

5 years ago

I'm in the early research stage and reading the PPM template attached to the Stanford search funds primer.  I was somewhat surprised to read this:

"Upon completion of a transaction, any funds remaining in the search fund will be returned to investors on a pro-rata basis.  Cash returned to investors will not be converted to securities in the acquired company (i.e., only capital consumed in the search process will be converted and stepped up)."

I have a feeling I might be getting ahead of myself here, as I haven't finished reading the document, but does that mean that some of the investment cash could go straight back to the investor without any interest for the investor's trouble?  Or is it usually not an issue because the investment is disbursed regularly in small amounts?  Or maybe not an issue because most search funders burn through their cash anyway?  What am I missing?

6 likes
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3 comments

professional from University of Southern California

More people would be happier if investors forced searchers to know how BEST to search before investors commit money.

5 years ago | like reply | 1 like

searcher from Texas A&M University

Hi Anne, The amount of capital consumed in a Search can be hard to predict. Salary is typically fixed, but the length of the search, due diligence requirements for a specific target, amount of travel conducted, and broken deal costs all vary widely. To balance the unknown capital need with the hassle of frequent capital calls SF investors typically sign up to contribute funds in two lump sums: ~50% up front gets the search started, and another ~50% in response to a capital call one year into the search process (if required). It is vary rare for an acquisition to occur in less than a year, but hopefully an acquisition is completed before the SF is completely exhausted, thus the need to have an agreement on what to do with the excess SF capital. Because SF capital typically receives equity with a 50% step up this funding is very expensive to the searcher. So the searcher only wants to take as much as they need to get to closing - and not a penny more! From the investor's perspective, contributing capital to a SF is essentially buying an option: the ROFR to invest in the acquisition. If the investor can purchase that option for less they are generally okay with it. The real carrot isn't the 50% step up on a $50k SF investment that might not result in an acquisition, its the 30% IRR on $500k invested in a good acquisition. Hope that helps!

5 years ago | like reply | 9 likes

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