Financial Returns of Search Funds: Analyzing the Data from 1984-2019
Search funds have become a notable path for aspiring entrepreneurs and investors alike, offering a unique avenue to significant financial returns and entrepreneurial leadership. The 2020 Search Fund Study, conducted by Stanford Graduate School of Business, provides comprehensive data on the financial performance of search funds formed in the United States and Canada since 1984. This article delves into the financial returns, examining key metrics such as internal rate of return (IRR), return on investment (ROI), and the overall equity value generated for investors and entrepreneurs.
Understanding Search Fund Financial Metrics
The primary financial metrics used to assess the performance of search funds are the internal rate of return (IRR) and the return on investment (ROI). IRR represents the annual compounded rate of return generated by an investment, while ROI measures the multiple of initial capital returned to investors. Both metrics provide crucial insights into the financial success of search funds over time.
Historical Performance and Aggregate Returns
Since 1984, traditional search funds have collectively raised over $1.4 billion in equity capital, resulting in approximately $6.9 billion in equity value for investors and an estimated $1.8 billion for entrepreneurs. This translates to an impressive aggregate pre-tax IRR of 32.6% as of the end of 2019, slightly down from 33.7% in the previous study. The overall ROI for investors stood at 5.5x, reflecting the multiple of initial investment returned.
The study also highlights the impact of outliers on these metrics. Excluding the top five highest-returning funds, the IRR for the remaining funds increased, indicating that the broader pool of search funds is performing well, with a larger number of high-return funds emerging.
Trends in Acquisition and Exit Activity
The number of search funds that successfully acquire companies has remained high, with 67% of all searchers making an acquisition. However, the percentage of searches ending without an acquisition has also increased slightly, from 31% to 33%. This underscores the challenges inherent in the search and acquisition process, emphasizing the importance of strategic planning and robust support networks for searchers.
Of the acquired companies, 75% achieved a gain in equity value, an improvement from 71% in the 2018 study. This indicates that while fewer searchers are completing acquisitions, those who do are experiencing a higher likelihood of success.
Impact of Acquisition Size and Industry
The size of acquired companies has shown a trend towards smaller deals, with the median acquisition price decreasing to $10 million in 2018-2019. Median revenue for acquired companies also dropped to $6.3 million, reflecting a focus on smaller but potentially high-growth targets. The median EBITDA multiple paid remained stable at 6.0x, indicating consistent valuation practices despite variations in deal sizes.
Healthcare, software, and tech-enabled services have emerged as popular industries for acquisitions, reflecting broader market trends and the potential for significant value creation in these sectors. The preference for industries with stable cash flows and growth potential remains a cornerstone of successful search fund acquisitions.
Key Lessons for Search Fund Entrepreneurs and Investors
The data from the 2020 study provides several key takeaways for both search fund entrepreneurs and investors:
Diverse Strategies Lead to Success: Both high-volume and deep-dive search strategies have their merits, and successful searchers often adapt their approach based on evolving market conditions and opportunities.
Importance of Robust Support Networks: Searchers with strong networks of mentors, advisors, and investors tend to have higher success rates in completing acquisitions and generating positive returns.
Focus on Growth Industries: Targeting industries with stable cash flows and growth potential, such as healthcare and technology, can enhance the likelihood of successful acquisitions and financial returns.
Smaller Deals, Higher Returns: The trend towards smaller acquisition sizes suggests that there are significant opportunities in the lower middle market, where companies can be acquired at attractive valuations and scaled effectively.
Conclusion
The financial returns of search funds, as evidenced by the 2020 study, continue to be robust, offering attractive opportunities for entrepreneurs and investors. With an aggregate IRR of 32.6% and a 5.5x ROI, search funds have demonstrated their potential to generate substantial wealth and entrepreneurial success. As the search fund model evolves, understanding these financial metrics and trends will be crucial for those looking to embark on this entrepreneurial path.
