Why do Search Funds Fail?

January 07, 2020

by a searcher from The University of Michigan - Stephen M. Ross School of Business in Ferndale, MI 48220, USA

By now many, if not most, of us have read the Stanford Primer on Search Funds. On the second page, it mentions that “More than one in four search funds have not acquired a company despite the principal(s) spending 24 months in this pursuit.” My question is why? Perhaps this is a naïve question because my business partner and I are still in the infancy stages of raising our fund. That said, it seems that with two whole years of research, due diligence, and fundraising, acquiring a company would be more than doable.

Do partnerships breakup? This is common in other startups, so I’d imagine that it may apply here. However, with proper research at the beginning, most search funders would have a general idea of what they’re getting into. I doubt that if one was able to raise the capital for an acquisition, they would choose not to invest. With that, my best guess is that, like most things, it comes down to money. Do most funds fail simply because they are unable to raise the required capital?

Reply by a searcher
in 1335 6th Ave, New York, NY 10019, USA

Owners are fickle and deals get derailed for a myriad of reasons. I've worked at funds where an acq. co. owner decides he wants a different valuation (as much as 1.5x EBITDA and cash on close) 2 weeks before projected close or an owner's family member gets sick and the process is delayed 6-9 months. Selling a small business is an enormously emotional decision for many owners and that engenders ample unpredictability and irrationality. Buying the wrong business is far worse than not buying one at all which I suspect militates (rightfully) against some hail-marys. Peculiar things get discovered in diligence; maybe revenue concentration is higher than originally expressed or key customer contracts won't get renewed, or revenue tanks during 6 months of discourse b/c owners lose focus. Or perhaps you get outbid on a couple LOIs and multiples are unreasonable b/c of macro events. Additionally, time prioritization is paramount in a search; you may be juggling 3-4 live deals, diligence, all while maintaining deal flow...it's challenging. Managing a team of undergrad college interns can be a huge time suck if you don't delegate and build efficient processes. In synopsis, closing a deal is analogous to logistics, the last mile is disproportionately taxing.

Reply by a searcher
from University of Virginia in St. Louis, MO, USA

I know someone who was involved with a search fund several years ago. Her job was lead generation and I became familiar with, and liked, everyone involved.

In that case the funding partners had unrealistic valuation expectations. They didn't want to buy anything unless the price was extremely low. They wasted a lot of time because of this and I suspect that they are not the only ones.

The problem with expecting a crazy low price is that you will spend an inordinate amount of time trying to find something. You're losing the return on a "lesser" deal while waiting for the extraordinary deal. Additionally, in better economic times you may not find anything.

It's kind of the same mentality as somebody who drives 5 miles for gas that 5 cents a gallon cheaper. You burn up the savings on the way home. There are a lot of people like that.

There are also a lot of people who just can't pull the trigger on the commitment and risk but don't understand that about themselves.

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