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Forbes
30-06-2025
- Business
- Forbes
Inside The Rise Of Search Funds: Private Equity's Hidden Gem
Krishan Arora is the Managing Partner at Novastone Capital, a PE group with over $440M in capital deployed across 23 global acquisitions. In the landscape of private equity and entrepreneurship, search funds have emerged as an innovative asset class. Originally conceptualized at the Harvard Business School in 1984 and further developed at the Graduate School of Business at Stanford, the search fund model has matured into a proven pathway for entrepreneurs, investors and mid-career professionals alike. The latest data from the Stanford 2024 Search Fund Study underscores the resilience and appeal of this model, even amidst larger global macroeconomic forces at play. For those entrepreneurs interested in pursuing this model, it's vital to understand the nuances and challenges. Understanding The Search Fund Model A search fund is an investment vehicle where mid-career professionals or entrepreneurs raise capital from a search fund program or private investors to search for, acquire, operate and then scale a privately held company. This business model offers an opportunity for these professionals or entrepreneurs to step directly into the role of the CEO of an existing small-to-medium-sized enterprise (SME). These SMEs are on average typically generating between $1,000,000 and $5,000,000 in EBITDA, so they sit on the lower end of the lower-middle market private equity world. These SMEs usually have around 30-50 employees, and have been in existence for over 10-plus years. What makes the search fund model unique is the hands-on nature of the investment. Unlike traditional private equity or turnaround initiatives, where operators are hired post-acquisition or post-distress, here it's the entrepreneur (searcher) who finds the deal and steps in to run the business. This creates a deep alignment of incentives between the operator and investor, and it also attracts a different kind of talent—the one that is hungry to build, not just manage. These searchers and mid-career operators are not buying high-growth startups; they are acquiring steady cash-flowing businesses that have been around for decades, and are then breathing new life into them. It is this unique mix of entrepreneurial grit and investor support that helps explain why this model has gained popularity. The Business Impact Based on the findings of the 2024 Stanford Search Fund Study (download required), which reviewed 681 search funds across the U.S. and Canada, these investment vehicles have the potential to deliver strong financial performance for investors. The report cites an average internal rate of return (IRR) of 35.1% in 2023 and 35.3% in 2022. The return on investment (ROI) for investors averaged 4.5 times. But these figures tell only part of the story. Behind each data point are real entrepreneurs and operators stepping into real leadership roles and transforming real SMEs. The consistency of returns across the many global market cycles suggests that this search fund model is more than a trend. It's starting to look like a unique path for investors and operators who are willing to take a long-term view and roll up their sleeves. The average hold period post acquisition is generally around 5-7 years, so it's generally in line with the holding period of many other appealing asset classes to investors. Growth And Evolution Over the past few years, the search fund landscape has undergone a massive transformation, sending a clear signal that a once-niche model is now gaining greater widespread traction and awareness. What's even more compelling is that the shifting profile of who is driving this momentum. The latest waves of searchers include more women than ever before, as Stanford found that 17% of all new fund managers in 2023 were women. At the same time, we are seeing a diversification in how these funds are structured as well. New variations like self-funded efforts, operator-led program-backed searches and long-term hold fund models are emerging, each offering tailored approaches to various groups of investors. Taken together, these trends point to a maturing high-IRR asset class that is becoming more inclusive, flexible and relevant in the volatile world of entrepreneurship. Challenges Of course, the road to success in this space is far from guaranteed. While the search fund asset class and model offer investor metrics and upside, not every searcher's journey ends with a closed deal. Roughly 60% of searchers acquire a business, meaning that the other roughly 40% try hard to land a deal but are not able to finalize their acquisition. And even when the acquisition happens, the real work is just beginning. Leading an SME through a transition and then a value creation plan is no small task; it's riddled with late nights and an uphill battle. For investors, this variability reinforces the need for a portfolio approach. Spreading capital across multiple searchers is a recognition that outcomes can vary based on industry, timing, the searcher and just good, plain old lady luck. Still, for many entrepreneurs and investors, the risk is part of the appeal. Search funds represent a rare blend of entrepreneurship and hustle, allowing operators to earn their way into equity and ownership while giving investors early access to often overlooked businesses with real IRR potential. As the search fund model continues to grow across geographies and adapts to new macroeconomic climates, it's attracting investors and entrepreneurs. Opinions expressed here belong solely to the author and do not reflect the views of their employer. The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation. Forbes Business Council is the foremost growth and networking organization for business owners and leaders. Do I qualify?
Business Insider
25-04-2025
- Business
- Business Insider
'Mini private equity' is exploding, but there are risks. The biggest dos and don'ts, according to experts
Judd Lorson became interested in search funds as a pathway to entrepreneurship while at the Yale School of Management and launched a fund shortly after he got his MBA. Even with the help of Search Fund Accelerator, which provided capital and mentorship, the road to buying a company turned out to be "messy and chaotic," Lorson said. In a research paper about his experience, coauthored by Yale School of Management senior lecturer A.J. Wasserstein, the former Navy officer described how he and his wife would search Zillow for homes when he was close to a deal, only to see their dreams evaporate when the acquisition fell apart and they had to start over again. Even after buying a business, the challenges continued, with Lorson once having to forgo pay for two weeks while waiting for a short-term loan from his investors to pay expenses. Search funds, sometimes referred to as "mini private equity," are having a moment. A 2024 Stanford Business School study found that the creation of such funds, which raise money to buy an existing small business, hit an all-time high in 2023 (the latest year studied) with more than 90 first-time search funds raised. Stanford found that the strategy is particularly popular among young people with nearly 80% of first-time fundraisers in 2023 clocking in at 35 or younger, including many freshly graduated MBAs. For every story of someone becoming their own boss and making millions, however, there's a story of a failed business or someone who never even buys one. Lorson wrote that he hoped his own challenges would help others see the "realities of this career path" before making the plunge. In an effort to help aspiring searchers, Business Insider spoke to search fund researchers and entrepreneurs about what they should know to make a clear and sober decision about their future. "Many entrepreneurs fantasize about a $10 million payday," said Wasserstein. And while this can happen, it's rare. Wasserstein's examination of the 2022 Stanford Search Fund Study found that only 16% of search fund entrepreneurs delivered a $10 million-plus payday, with an average payday for those who managed to sell their business at $5.7 million. "It is rare and not easy in any way," Wasserstein said of the big payday. "Understand what needs to happen for that to be a reality." Don't plan a vacation anytime soon Being the boss means you're never really off the clock. This can create challenges in your personal life and prevent you from taking a vacation — or even a weekend off. Chad Howard, who left his corporate job to start a portable toilet rental business last year, has dealt with this firsthand. Howard was visiting family out of state when one of his largest clients called to say that they had an emergency and needed 10 portable toilets delivered as soon as possible to a location that had just run out of water. He would have just delivered the toilets himself, but he wasn't nearby, and none of his usual workers were free. "I just don't travel as much as I used to because that feeling when you have to coordinate everything by phone feels terrible," he told BI of the experience. Howard said the pressure to be available is magnified by the desire to make a good impression as a new business owner. "Work-life balance exists in corporate America because most things aren't an actual emergency," he said. "Someone might say that, but in reality, if something comes in at off hours, it can wait until the next day, and nothing bad will happen." Howard said you have to be able to solve problems when you're in charge. Gone are the days when he could sleep in until 8:00 a.m. on the weekends or easily plan out when he could fit in a workout. It's more exciting, but it's much harder to have a "normal" day. Don't expect to walk away when you sell According to the Search Fund Primer, the typical search fund timeline involves two years of searching for a business, followed by five to six years of operations before exiting a company, usually through a sale. A study conducted by Wasserstein, however, suggests that an "exit" doesn't necessarily mean the commitment to the business is over. Wasserstein found that more than three-quarters of sales were to private equity firms or companies backed by private equity. And the majority of entrepreneurs making these deals maintained stakes in their businesses. "Our data says that 65% of exiting searchers roll 25% to 49% of their equity," Wasserstein said. "Additionally, they need to stay with the acquirer for approximately two years." They often have to stick around as CEO under a private-equity boss, which can present a whole new set of challenges. Instead of answering only to their investors, searchers may also be beholden to their new owners. Wasserstein's study found that these new owners have a net promoter score of negative 33, which suggests that search funders who've sold are more likely to be unhappy with their new partners than not. The pay is better, however, with the majority of those who stick around for more than five years with their new equity partners making more than 30% more than they did when they were running the business themselves. Be prepared to give up Half of search funds fail. According to the 2024 Stanford search fund study, 37% never find a business, while 19.5% fail to make a return on investment. Another 5% have actually lost all of their equity. Failure is part of the game in entrepreneurship, and the earlier you can deal with it, the better your career. The inability to accept failure can be costly as it can lead searchers to stick by businesses that aren't working. "Our data says that entrepreneurship through acquisition CEOs and investors hang on to floundering businesses for too long," Wasserstein said, adding that "bad companies tend not to recover." His research categorizes search fund failures into three categories: no-dealers, imploders, and drifters. No-dealers never find a company, which can be emotionally challenging but doesn't carry nearly as much risk of long-term negative impacts. Imploders fail soon after acquisition, which can be traumatic, but means that the searcher hasn't put too much of their career into it. Drifters hold on because they're determined to improve their companies, but, as Wasserstein writes, "time is a vicious enemy." "If a drifter runs a business for five to ten years in perpetual anticipation of breaking out the next year, time becomes fleeting," he wrote, adding, "If a searcher is a decade into a project at 45 years old with no equity to show for their efforts, they understandably feel frustrated and disappointed." The longer an entrepreneur spends with a failing business, the worse the impact on their lifetime earnings and professional opportunities. It can even lead to "emotional and physical wear," he said, and can have a major negative impact on their relationships. "As the CEO relentlessly fights to improve the company, they often neglect their health, friends, and family," Wasserstein wrote. " More often than not, the CEO's spouse, closest friends, and family realize perseverance is futile before the CEO admits this to themself." Find a peer group or mentor There are many guidebooks, most notably the Stanford Search Fund Primer and the Harvard Business Review's Guide to Buying a Small Business, to help searchers navigate the process, and a range of online influencers and communities. But it's also important to find people you can call in a jam. Finding and running a business is "far more demanding than it appears on paper," said Newton Campos, professor of entrepreneurship at IE University in Madrid and the founding partner of Newton Equity Partners, a recently launched fund that invests in search funds. You must be a capable fundraiser, negotiator, sales agent, and business operator. And because investors are often buying someone's "life's work" or "a piece of family history," it requires emotional intelligence alongside modeling skills. If you're in graduate school, find a professor or alumnus you can lean on. People coming from the business world might want to find investors who have the time and ability to act as a guide or mentor, or work with an accelerator like Lorson did. Finding support can also help emotionally. Searchers often move to new cities to start their businesses, which can leave them socially isolated and much too busy to make friends. Also, being the boss can be lonely, as Josh Leslie, a CEO, told BI back in 2019. "I don't get to go to lunch and complain about the boss with my coworkers," he said. "My role in the company is unique and uniquely isolating."
