The Basics of Search Funds

Searchers and investors explore innovative investment vehicle at IESE’s 2nd International Search Fund Conference

28/10/2016 Barcelona

iStock | Andrew Rich
Why are search funds gaining traction in Europe? / Photo: iStock | Andrew Rich

What is a search fund? What makes a good searcher? Why raise or invest in a search fund? What happens after acquisition?

These and other questions dominated the 2nd International Search Fund Conference’s primer session this week. The two-day conference, which has brought entrepreneurs and investors working with European, Latin American, African and Asian search funds to IESE’s Barcelona campus, aims to build connections and provide a better understanding of the search fund model.

Moderated by Blake Winchell, managing director of Partner Ventures and Fremont Ventures, the panel explored the nuts and bolts of search funds.

The Anatomy of a Searcher

Winchell, who runs two Silicon Valley venture capital firms, defined search funders as entrepreneurs who want to grow an existing company rather than start one from scratch. Most tend to be relatively young, many being recent MBAs. By bringing seasoned investors on board, they not only acquire the capital they need, but access to valuable experience, knowledge and guidance.

Jürgen Rilling, owner and managing director of investment and consulting group Mirablau, explained that the ability to “learn and listen,” a “deep understanding of the search fund model” and the “type of company they are looking for” are key searcher attributes.

“Searching is tough,” Rilling said, and searchers need to be committed.

Why Raise a Search Fund?

Kilian Lamprecht and Guy Solomon, the panel’s two search funders, shared their experiences and reasons for taking the search-fund route. For Lamprecht, managing director of Frankfurt-based Succession Associates, it was about acquiring an “existing business” and making it grow. He said the “beauty of the search fund model” is having the backing of experienced investors “who have been there before.”

What drew Guy Solomon, managing director of Tel Aviv-based Trail Mark Partners, to the model was the “managerial challenge,” the need to really “understand the business.” Winchell pointed to the model’s lack of “market acceptance risk,” a major benefit. The type of companies searchers seek are already well-established, staffed, and generating revenue.

Building the Fund

Jon Herzog, a partner in Goodwin Procter’s Private Equity and Technology Companies Group, looked at structuring and raising a search fund. “Keep it simple” during the search stage, the search fund attorney advised, especially when drawing up partnership agreements. Herzog also compared and contrasted U.S. search funds, where searchers have “almost complete affirmative control,” and European funds, which usually rely on a board of investors.

Rilling went on to examine the composition of the investor group, emphasizing the need for a “high share” of “serial” search fund investors to ensure efficiency. He also highlighted the need for different types of investors who can contribute in different ways: “local mentor investors” who provide guidance and credibility; European investors with “search fund and operational experience;” and “deep pocketers from the US” who may be able to “fill funding gaps” during the acquisition stage.

The Searcher Ecosystem

The search fund community is collaborative in spirit, with searchers regularly exchanging “experiences and best practices,” according to Lamprecht.

Guy Solomon weighed in on smaller market searches and the challenges and opportunities of being the first in a given market: unfamiliarity with the search fund model might make raising the fund harder, but low competition provides a definite advantage.

According to Winchell, “first-time CEOs” should look for companies with “high levels of free cash flow,” and Rilling added “a history of growth” and “low complexity” as desirable features to ensure smooth post-acquisition operations. Herzog urged searchers to get a clear picture of the seller and how he or she might change “on the other side of the deal.”

When approaching potential sellers, cultural awareness is key, and here feedback from international searchers can be helpful. Sellers might also be unfamiliar with the search fund model, but Winchell discouraged searchers from “educating the owner.” What matters is that they see a “serious buyer” backed by an equally serious investor group. Many owners, Solomon remarked, have never “thought of selling.” With the right approach, Winchell told searchers, they can “create a company for sale” where there wasn’t one before.

Closing the Deal

The deal, Herzog said, is like “writing a book” with several co-authors, which include the seller, the bank, their respective lawyers, and the searcher’s investor group. The most time-consuming chapter is the purchase agreement. This is unfamiliar territory for first-time searchers, as well as many owners who might never have sold a company before.

Winchell reminded searchers that selling a company, especially one built over time, perhaps even generations, is a “very emotional experience.” Returning to the idea of soft skills, he mentioned the need for “emotional intelligence,” encouraging searchers to help the seller reach the “yes” in a process resembling a “delicate dance.”

Equal finesse is required when searchers first meet with employees after acquisition. Reassuring them is decisive to stability. Tell employees that they are part of what makes the company great, said Winchell. In closing, Winchell reminded searchers of three ways they can add value to companies:

  1. Introducing new technology to increase competitiveness
  2. Upgrading the sales force to add sophisticated skill sets
  3. Designing incentive structures to align company goals