Traditional to self funded? Seeking advice & experience.

April 23, 2024

by a searcher in Denver, CO, USA

Seeking some advice. Launched my traditional fund in 2022 and coming up to the end. I found some really interesting businesses, submitted several LOIs, but have failed to get a deal across the finish line. There are a few "smaller" deals that don't fit the traditional model that I am interested in pursuing at this point. When I say they "dont fit the traditional model" I mean they are too small, have hair on the deal - investors wouldn't be excited and neither would I with traditional SF economics. Has anyone decided to close their traditional fund to then pursue a smaller deal they found? Was there something you did to make your investors "whole"? Thanks in advance.

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Reply by a professional
from University of Toronto in Toronto, ON, Canada

I agree with the general theme expressed in several comments above; namely, that your original investors knew the risks and (should have) understood that there may not be a return on their investment in your search. That being said, there are several important caveats. First, was it clearly set out in your original search fund agreement that the investors might lose all of their investment; if not, then you may have a disclosure problem and resultant liability. Second, as ^redacted‌ noted, the terms and conditions of your original search fund agreement are important: if there were holdover clauses of any kind, then you may have legal obligations to not pursue deals that you originally sourced while in the search fund or, at least, not without the consent of the original fund (and, as Mark Rice also notes, if the original fund doesn't consent, then move on). Thirdly, if you choose to try to reimburse your original investors in any manner, you have a moral and ethical obligation to treat them all equally; do not exhibit favouritism, do not reimburse some and not others.

Reply by an investor
from Stanford University in Bellevue, WA, USA

I closed my search fund in 2000 right before the Internet bubble burst after 2+ years of searching. It was a difficult decision but looking back, it was the right decision to make. I then did what many would consider to be a self funded search in 2002 during the depths of the bear market which turned out to be much better timing and bought several small non-search fund type businesses. So yes - it can be done. Although in my case, there was a couple of year gap between the efforts.

I spoke with Prof Irv Grousbeck about paying the initial investors back. He told me that it was not necessary as all the investors "wore big boy pants" and understood the risks. I did end up paying back some of the smaller / less sophisticated investors.

However, If you end up buying a business that you sourced while doing your search fund, it may make sense to carve out a small piece of equity for your previous investors. At a minimum, I would give them the option to invest.

At all times, I would recommend being up front and honest with your investors.

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