Small businesses are experiencing a period of unprecedented transition. Baby boomers make up more than 50% of today's business owners. Many are approaching retirement without a firm succession plan in place. One form of business succession has grown in popularity over the past decade -- sponsored entrepreneurship.
At its most basic level, this is an individual or small group raising funds from investors with the goal of purchasing and operating a single business. One of the fastest-growing forms is a search fund.
A search fund is an investment fund in which a single individual (known as the "searcher") raises a modest amount of money, and uses that money to search for business to buy and operate. Since 1984, over 325 funds have been raised with approximately 30% of those funds raised in the last five years. Top MBA programs, such as Harvard, Stanford, University of Chicago, and MIT are churning out eager graduates who see this as an opportunity to have a more hands-on CEO role than would be typical in a more traditional post-MBA path to consulting, investment banking, private equity or venture capital.
The process begins with a searcher raising initial capital funds of $350,000 to $450,000 from private investors. This capital funds a two- to three-year period when the searcher identifies, evaluates, negotiates and closes on the purchase of a business to operate.
Search funds generally focus on businesses with $10 million to $50 million of revenue; and $1 million to $5 million of profitability.
Searchers will evaluate up to 500 businesses on their way to acquiring one business to operate. This business must have a strong culture, fit the searcher's industry of interest and provide the appropriate growth potential.
Once the searcher identifies the right business, he or she will need to raise a second round of equity to fund the purchase of the company. Investors in the initial search receive a 50% ownership bonus in the acquired business.
This means, if you helped pay for the search, your $1 of investment toward the business purchase, gets you $1.50 of equity.
There is, however, substantial risk involved in forming a search fund. The long-term statistics show roughly half of all search funds fail to acquire a business before the search capital is depleted. The quest for the right business becomes the searcher's full-time job. While the investors have money at risk, the searcher incurs significant opportunity cost as they are losing two to three years of professional development. The potential upside is also significant. For those searchers who close successfully, they are left with the rewarding task of owning and growing a business; purchased alongside a group of dedicated investors and board members.
There is also great value in selling a small business to a search fund entrepreneur. This group of individuals sees the rise of baby boomer founded businesses, with owners approaching retirement, as an opportunity to fulfill their entrepreneurial spirit. Searchers are dedicated to operating one business -- relying upon the people, processes and brand recognition built by the founder.
Unlike other forms of transition, such as selling to competitors, search funds are seeking successful businesses with the goal of continuity. This can be an attractive option for a founder who is ready to retire, but wants to see their business continue on for the benefit of their employees, customers and legacy.
• Michael Kidd is a partner with Mowery & Schoenfeld, LLC, an accounting and consulting firm in Lincolnshire. He is the Transaction Advisory practice leader, where he specializes in working with searchers from fund formation through closing; as well as ongoing consultation and financial services for privately-held businesses and entrepreneurs.