Search Fund Model vs. Independent Search: Comparing Approaches to SMB Acquisitions
The search fund model and the independent, self-funded search are two popular paths for entrepreneurs looking to acquire and operate small to medium-sized businesses (SMBs). Both models involve identifying, purchasing, and running an established business, but the strategies, funding structures, and levels of autonomy differ significantly. Understanding these differences can help aspiring entrepreneurs choose the path that aligns best with their goals, resources, and risk tolerance.
In this post, we’ll explore the traditional search fund model and the independent self-funded search, comparing the pros and cons of each approach to help you make an informed decision.
1. The Traditional Search Fund Model
The search fund model was first developed at Stanford University in the 1980s and has since become a popular approach for aspiring entrepreneurs seeking to acquire and operate a business. In a traditional search fund, an entrepreneur (or a pair of entrepreneurs) raises capital from investors specifically to finance the search for a business to acquire. Once a suitable acquisition is identified, additional funding is raised from the same investors or new investors to finance the purchase.
Key Features of the Traditional Search Fund:
Investor-Backed Search Process: The entrepreneur raises initial capital from investors to fund their salary and search expenses (e.g., travel, due diligence, legal fees) while they look for a target company.
Established Network and Support: Investors in search funds typically offer not just capital, but also mentorship, industry expertise, and connections that can help in finding and evaluating deals.
Equity Sharing with Investors: In exchange for their financial backing, investors receive equity in the acquired business. The entrepreneur also receives equity but typically a smaller share compared to the investors.
Pros of the Traditional Search Fund:
Financial Support During the Search: Entrepreneurs receive a salary and expense coverage during the search phase, allowing them to focus full-time on finding the right acquisition.
Access to Capital and Expertise: Traditional search funds benefit from a network of experienced investors who can provide guidance, industry insights, and additional capital for the acquisition and growth phases.
Structured Process: The traditional model offers a well-defined path with proven methodologies, reducing some of the risks associated with finding and acquiring a business.
Cons of the Traditional Search Fund:
Equity Dilution: Because the entrepreneur raises capital from investors, they typically end up with a smaller share of equity in the acquired business. This can reduce the potential upside if the business is highly successful.
Investor Expectations and Control: With outside investors come expectations for returns, strategic input, and potential pressure to achieve growth targets. Entrepreneurs may have less autonomy in decision-making.
Time Pressure: The structured nature of the traditional search fund often comes with a timeline for finding and acquiring a business. This pressure can lead to rushing into a deal that might not be the perfect fit.
2. The Independent Self-Funded Search
In an independent self-funded search, the entrepreneur uses their own savings or limited outside capital to finance the search and acquisition. This model is often pursued by those who prefer more autonomy and are willing to take on more personal financial risk in exchange for greater equity and control.
Key Features of the Independent Self-Funded Search:
Entrepreneur-Driven Financing: The entrepreneur typically funds the search expenses out of pocket or with limited support from close contacts (friends, family, or angel investors). The acquisition is then financed through a mix of personal funds, SBA loans, seller financing, or other creative financing structures.
Full Ownership and Control: The entrepreneur typically retains a much larger share of the equity, giving them more control over strategic decisions and the business’s future direction.
Flexibility and Autonomy: Independent searchers have the freedom to explore a wider range of deals without being tied to investor mandates or timelines.
Pros of the Independent Self-Funded Search:
Greater Equity Ownership: Entrepreneurs in a self-funded search typically keep the majority of the equity, allowing them to capture a larger share of the financial upside if the business performs well.
Autonomy and Decision-Making Freedom: Without outside investors, entrepreneurs have full control over strategic decisions, growth plans, and the overall direction of the business.
Flexibility in Search Criteria: Independent searchers have the flexibility to pursue smaller or more niche businesses that might not meet the size or industry requirements of traditional search fund investors.
Cons of the Independent Self-Funded Search:
Personal Financial Risk: The entrepreneur bears a much greater financial risk, as they are using personal savings and possibly taking on debt to fund the search and acquisition.
No Salary During the Search: Unlike in a traditional search fund, self-funded searchers do not receive a salary during the search phase, which can lead to financial strain if the search takes longer than expected.
Limited Access to Capital and Expertise: Independent searchers may not have the same access to capital or the investor network that a traditional search fund offers. This can make it more challenging to find, evaluate, and close deals.
3. Comparing the Two Models: Which Is Right for You?
Both the traditional search fund and the independent self-funded search have their advantages and trade-offs. The right choice depends on your personal goals, risk tolerance, and the type of business you want to acquire.
Traditional Search Fund: Best for Those Who Want...
Access to Capital and Expertise: If you want the backing of experienced investors and a structured approach to the acquisition process, the traditional search fund is an excellent option.
Reduced Financial Risk During the Search: Receiving a salary and having search expenses covered can be attractive if you want to focus full-time on the search without draining your personal savings.
A Larger, More Established Business: Traditional search funds tend to target larger businesses (with EBITDA typically between $1 million and $5 million) that require significant capital for acquisition.
Independent Self-Funded Search: Best for Those Who Want...
Greater Equity and Control: If you’re willing to take on more personal financial risk in exchange for retaining a larger share of the equity and full decision-making authority, self-funding is a better fit.
Flexibility and Freedom: If you value the ability to pursue niche deals, operate on your own timeline, and maintain control over the entire process, the self-funded approach offers more autonomy.
Smaller, Niche Businesses: If you’re interested in acquiring a smaller business (with EBITDA under $1 million) that may not appeal to traditional search fund investors, the self-funded search gives you the flexibility to do so.
4. Hybrid Models: The Best of Both Worlds?
In recent years, some entrepreneurs have pursued hybrid models that combine elements of both traditional search funds and self-funded searches. For example, some searchers raise a small amount of capital from a select group of investors to fund their search, while still retaining the majority of equity. This approach allows for some financial support and access to expertise without the full dilution and control trade-offs of a traditional search fund.
Conclusion: Choosing the Right Path for Your Acquisition Journey
The decision between a traditional search fund and an independent self-funded search ultimately comes down to your goals, risk tolerance, and preferred working style. The traditional search fund offers financial support, a structured process, and access to expertise but comes with equity dilution and investor oversight. On the other hand, the self-funded search provides greater autonomy, flexibility, and equity ownership but requires more personal financial risk and self-reliance. By carefully weighing the pros and cons of each approach, you can choose the path that aligns best with your long-term objectives and entrepreneurial vision.
