Why Search Funds Provide Higher Returns
Search Funds are
making their mark as an attractive investment vehicle, delivering higher
returns than comparable classes. This superior performance is coupled with an
ongoing global boom in search funds. It speaks volumes about their potential.
But what sets them apart?
First, What is a Search Fund?
Traditionally, it is a company that one (sometimes two) entrepreneur founds for the purpose of buying and running a single, existing business that has a history of annual profits in the range of $1-2 million dollars. Once the business is acquired, the new CEO, their anchor investors and the search fund, aim to grow, operate, and (usually) sell the business in 5 years. This novel approach to entrepreneurship was developed at Harvard Business School in 1984. The model is also known as entrepreneurship through acquisition, or ETA and it has been wildly lucrative since then.
We’re talking about acquiring long-running, stable, profitable businesses. A startup business is like building a plane while you learn to fly it, whereas ETA is stepping into the cockpit of a plane that has been cruising for years with an experienced crew. Historically, 91 % of businesses maintained or grew their profits after being acquired by a Search Fund using the ETA model.
A 40 Year History of Returns to Investors
According to the biennial study from the Center for Entrepreneurial Studies at Stanford Graduate School of Business Search Funds, since 1984, have generated over $10 billion for investors, recently achieving an annual record $776 million for 2020-21. Over the 38 years since 1986, slightly more than 73% of Search Funds have yielded positive returns to investors. Compare that to the 90% failure rate of startups. On average Search funds had a return on investment of 5.2x and an internal rate of return of 35.3% per year for investors.
The Booming Landscape of Search Funds
Search funds have seen a meteoric rise in popularity, with international activity also reaching unprecedented levels. This is in part due to more people becoming aware of the ETA model and the Silver Tsunami.
Nearly 80% of Baby Boomer (born 1946-1964) business owners have not taken any steps to transition ownership of their business to new, younger owners. As a result, over the coming years there will be a flood of profitable businesses for purchase as these owners retire. This is what is affectionately called the Silver Tsunami. The Baby Boomer generation accounts for an estimated 2.3 million small businesses in the U.S. Additionally, 78% of boomer businesses are profitable, making them the most profitable age group of small business or franchise owners. Furthermore, experts estimate that roughly 10,000 Baby Boomers retire each day. There is an over supply of lucrative businesses ripe for the picking, creating a buyer’s market for Search Funds. [7]
In past two years, 75 new funds were established, with 38 successful acquisitions globally, indicating a vibrant and dynamic landscape. Diversity is growing amongst Search Fund founders. Both the number of search funds launched by women rose from 10% in 2020 to 13% in 2021 and the number of non-white founders grew to 40%. These trends are a testament to the growing acceptance, popularity and diversity of search funds worldwide.
How Search Funds Drive Higher Returns
The secret to the success of search funds lies in their unique structure and strategy. Success is typically measured in two broad categories: acquisition rates and return on investment. Search funds, with their nimble size, have a knack for focusing on acquisition details, working closely with selling business owners to ensure efficient and successful outcomes. Since 2014, 60% of search funds have seen success in their acquisitions, a promising statistic that underpins their potential for high returns.
Moreover, search funds offer greater diversification opportunities. They are not tied to specific industries, allowing them to take advantage of strategic opportunities across various sectors. This flexibility, coupled with the intimate involvement of fund managers, often leads to superior returns.
The Future of Search Funds
The future looks bright for search funds, with trends pointing towards increased standardization, efficiency, and democratization of the asset class. This evolution makes the asset class more accessible to a wider range of investors, broadening its appeal.
Furthermore, societal shifts and technological advancements are expected to influence the future of search funds. With the rise of digital technologies, search funds have new avenues to explore and new ways to maximize returns.
Wrapping Up
Search funds offer an enticing prospect for investors seeking high returns. However, like any investment, they come with their own set of risks and challenges. As such, investors need to carefully consider their investment goals and risk tolerance before venturing directly into a search fund or find experienced money managers or a fund that specializes in it.
Despite these risks, the proven ability of search funds to deliver superior returns, their increasing popularity, and the promise of their future, make them a compelling proposition in the private equity space.
*References:*
1. “Search funds in Europe: 2023 trends and 2024 predictions – LinkedIn” https://www.linkedin.com/pulse/search-funds-europe-2023-trends-2024-predictions-moonbasecapital-r0bzf
2. “Search funds continue to go global | IESE Insight” https://www.iese.edu/insight/articles/search-funds-continue-to-go-global/
3. “Search Funds Show Strong Performance in Acquisitions and Returns” https://www.gsb.stanford.edu/insights/search-funds-show-strong-performance-acquisitions-returns
4. “Search Funds from the Investor’s Perspective | Toptal®” https://www.toptal.com/finance/private-equity-consultants/search-fund-investor
5. “Search Funds: An Alternative Path to Entrepreneurship” https://entrepreneurs.princeton.edu/news/2024/search-funds-alternative-path-entrepreneurship
6. “The astonishing profitability of the Search Funds – LinkedIn” https://www.linkedin.com/pulse/astonishing-profitability-search-funds-enrique-quemada
7. “How the Silver Tsunami provides acquisition opportunities for veterans” https://resources.liveoakbank.com/blog/how-the-silver-tsunami-provides-acquisition-opportunities-for-veterans