A partner and I are currently in the information gathering, planning, and networking phase as we evaluate the prospects of raising a traditional search fund focused on acquiring a business in Canada. We are looking to connect with other prospective searchers, current searchers, former searchers, advisors, and investors as we seek to gather information on a couple specific questions.
We have determined that a traditional search fund would be more appropriate in our situation than a self-funded search to provide access to a group of experienced mentors for guidance (especially valuable for operating expertise given we both have financial backgrounds) and to provide enhanced credibility for transactions.
Below is a list of questions that we would greatly appreciate any perspectives on, along with some thoughts from our research so far. Please feel free to respond directly to this post or we would be happy to jump on a call at your convenience to further discuss.
1) Is an international search fund (specifically Canada in our instance) disadvantaged from a fundraising perspective (specifically from institutional capital or traditional search fund investors)?
- Generally speaking, how important is jurisdiction (specifically Canada vs. US) for the institutional investor base?
- In our research, we have come across discussions that international search funds typically require 50% of the capital to be committed from investors in their home country. In contrary, some of the search funds in Canada that we have researched seem to have a majority of their commitments from the traditional US search fund LPs.
2) As most traditional searchers seem to come from an MBA background, would we be disadvantaged or “filtered” out as individuals without MBA’s? Is this something that investors weigh heavily when evaluating prospective searchers?
3) Thoughts on raising capital amidst the current economic backdrop and are investors actively investing capital during these challenging times?
- Empirically, our research suggests that search fund fundraising activity has dropped substantially with recessionary environments (immediately during the dot-com bubble or in the years following the global financial crisis) that we speculate is due to a number of factors, including: capital constraints, elevated cost of equity, reduced risk appetite, and investors preference for liquid investment alternatives. With that said, we are curious to understand thoughts on the subject given the rather unique macroeconomic landscape we are in?
- Furthermore, we believe that making an acquisition post a recessionary environment actually enhances the attractiveness of search fund as it provides a recent demonstration of the resiliency of the target's earnings, reduces competitiveness given the restricted access to capital (specifically, lower middle market PE firms and family offices shift their focus to assisting their existing portfolio), and moderation of valuations across all asset classes.
4) Thoughts on the composition of the investor base for the search capital in a traditional search fund?
- Our initial thesis is that it would be best to have a majority of the investors as high net worth individuals or institutional investors that are capable of writing a larger cheque for the acquisition capital. Although we recognize that family, friends, and business associates that personally know us will provide validation to other investors, we are curious to know what proportion of the investor base is required to provide this validation vs. balancing the investor base with those who can actually fund their proportion of the acquisition capital (if desired) and add value pre-and-post acquisition.
As a side bar, I am working on gathering summary notes from all of our research along with links to various reports, articles, videos, and other useful information sources. Once complete, I will post the document for the community to help others along with a Google drive aggregating information.
Thank you to everyone in advance.
Troy
1.) My own experience dictates that investors are generally adverse to investing in a new geography (as in new for them, not necessarily new to the search fund community). Having said that, many investors in the search fund community will co-invest with investors they've done deals with before, even if it is in a geography they've not done business in before.
If I were in your shoes, I would prioritize investors from Canada or international investors that have previously invested in Canada. They will then hopefully be in a better position to provide you advice and connections when it comes to conducting your search or operating your business.
2.) Nothing more to add to Philip's point.
3.) I think everyone understands that investing in a downturn is the key to outsized results. The key really is to identify which opportunities are salvageable and which ones are already train wrecks. You could really go from hero to zero in today's climate.
4.) I am generally of the belief that the fewer people you have in your cap table, the better it is (though perhaps that's the VC part of me speaking). Once you're running your business, you want to be fully focused on making that business a success, and spending only a little bit of your time in keeping your investors informed. If you have 20+ people in your cap table, that becomes a lot more difficult.
1) I can't speak to Canada but in other countries I've been involved with searches the majority of LPs have been based in that respective country. I think that between the Canada and the US there's a bit more interaction, but I imagine if you're looking to buy a Canadian company, you'd want Canadian investors, or American investors with international experience (makes your fundraising funnel a little smaller). If you're looking to buy an American company but based out of Canada, then it doesn't make a difference if your LPs are American or Canadian.
2) There's exceptions to the rule but they usually look for at least one of the searchers (if searching with a partner) to have an MBA. People with heavy operating experience and proven success (through the form of exits) have an easier time getting a pass. It is what it is.
3) LPs are definitely tightening up but I'm in agreement with your second bullet that this is counterintuitive. There are tons of great acquisition targets right now.
4) You want investors that will get behind what you're doing and can be a reliable source of capital when called upon. Most acquisitions are levered so the upfront costs are significantly less than one might expect (hence a lot of searchers having an LP base of 25-50 "angels" writing small checks), but you want to have at least a few that can double down and help growth through additional financing. I personally prefer working with operators that have become investors, rather than investors who don't have previous operating experience.
Hope this helps.