Search Funds: The Goldilocks of Buyers?

The M&A market is booming, and for entrepreneurs and family businesses seeking to capitalize on a historically great seller’s market, some are finding that the lack of long term planning is weighing on valuation.   As we approach the end of a historically great M&A market it’s important to start thinking about trading some smaller portion of value in return for a deal that closes while the market is still at its high point.

Typically, sellers seeking a 3rd party sale have two options: a sale to a “strategic buyer” or to a private equity group (“PEG”).   However, what sellers often find is that premium valuations and fast exits often require years of preparation.   For the right profile though, there is a type of capital that might fit the bill: search funds.

Why Strategics and PEGs Aren’t Always Right

Here’s a simple fact: buyers are picky.  They want what they want, and are often patient enough to wait for the right opportunity.  This is especially true for strategic buyers: they care about product / portfolio fit, they worry about things like channel conflict, and they are concerned about culture.  There’s a common misconception that as a seller you are instantly attractive to the market.  At a high level perhaps, you are, but to realize strategic value you also need to find that perfect strategic fit – and that takes time.

Financial buyers are different of course.  With a PEG you’ll often find acquisition criteria devoid of mentions of culture and channel conflict.  What will you find?  Beyond pure financial metrics, PEG’s need an intact management team since they will not be operating the business themselves.  This is a struggle for most family businesses and lower middle market businesses: often owners are the management without significant depth behind them.  Management depth isn’t an issue if you are good with staying on for a few years, but a fast exit is off the table.

Enter the Search Fund

A search fund is a form of a “fundless sponsor” operated by an entrepreneur looking to acquire and operate a single company.  To a large extent, it’s a blend of an individual buyer and private equity.

How can a search fund fill in the gaps?

Owner Operator Mitigates Management Depth

The key is in the fact that the entrepreneur will operate the business.   As the entrepreneur will be there day to day, there isn’t a need for a long transition.  In fact, while most deals provide for some sort of transition services agreement, experience suggests that most entrepreneurs are ready to dive in and let the seller step away.

The Un-Perfect Fit

Because the deal is “one off,” there isn’t an overarching need for a perfect fit.   A search funder doesn’t have to worry about combining distribution channels, vendor conflicts, or achieving synergies in sales channels.  There’s no need to rationalize a line card.  The entrepreneur will likely be looking for a company that they feel that they can scale without having to rely on a legacy business to be able to do so.

The Downside

Given the requirement to be an owner operator, the acquirer will lack a safety net of existing management’s experience and knowledge.   This often translates to deeper due diligence.  Additionally, because there is no strategic fit, valuations will likely be closer to fair market value than strategic value.

Wrapping it Up

Understanding how the market may perceive your company is key to a successful transaction.  One frequent tradeoff is a high valuation versus the length of time to find that perfect buyer.   And with management depth a frequent problem, transitions can often be measured in years as buyers safeguard their investment and seek conveyable value.  The current market is such that we are likely at the peak of a historically great M&A environment.  Waiting too long for the perfect deal could mean missing the market.  If that’s a concern, a search fund could be the perfect counterparty for your deal.