WHAT IS A SEARCH FUND?
One of the fastest growing niches in alternative asset management.
Search funds are one of the fastest growing niches in alternative asset management. Targets, in the $10-20M EV range, demonstrate a profitable operating history.
2 to 4 mo.
Pioneered by Stanford GSB Prof. Irv Grousbeck in 1984, a search fund is an investment vehicle that enables an entrepreneurial team of one or two searchers to purchase and operate a small business for the long term.
Searchers first raise a small pool of search capital of $300-600k from 10-20 investors to fund the travel, due diligence, and admin expenses of a 2-year search.
Most targets have healthy margins, years of profitable operating history, $10-20M EV, B2B recurring revenue, low capex requirements, and growing industries.
SEARCH & ACQUIRE
6 to 24 mo.
By investing in the search capital, LPs obtain the right but not the obligation to participate in the potential acquisition on a pro-rata basis.
Once searchers identify a target, they present the deal to the investors and solicit a second round of funding, oftentimes using modest leverage as well.
Post-acquisition, searchers take managerial roles within the company and receive carried interest in the common equity.
MANAGE & GROW
4 to 7+ yrs.
Searchers usually focus on organic growth, utilizing various operating levers, rather than employing financial engineering and roll-up strategies.
Investors typically have decades of transaction and industry experience, so they take board seats to help searchers avoid rookie mistakes.
Searchers tend to operate businesses for many years, providing an important selling point when pitching transactions to owners.
3 to 6 mo.
Searchers provide investors with liquidity via sales to financial or strategic buyers, and periodically through dividends and recapitalizations.
Investors receive a preferred return, in the form of a coupon, before searchers receive any carried interest. This coupon varies meaningfully depending on the country, interest rate environment, and perceived idiosyncratic risk of the investment; the coupon may accrue on all or only a predetermined portion of the preferred equity.
US & Canada Search Fund Performance
International Search Fund Performance
Sources: 2016 Search Fund Study, Selected Observations, Stanford Graduate School of Business, 6/27/2016; International Search Funds-2016, Selected Observations, IESE Business School | EIC, June 2016.
80% of international search funds have been raised after 2008, resulting in lower historical performance since the highest performing business have had less time to compound.
Stanford GSB and IESE study figures as of 12/31/15. Past performance does not guarantee future results.
WHY DO SEARCH FUNDS WORK?
Passionate entrepreneurs leverage decades of investor experience to generate superior returns.
Small transactions of $10-20M EV fly below the radar of traditional PE firms, allowing for lower purchase prices and multiple expansion upon exit.
Searchers receive most of their compensation in the form of common equity that vests over time and pending the company’s performance, aligning incentives with investors.
Many SF investors have executed successful searches themselves and spent decades investing in the asset class, allowing them to steer the searchers away from common pitfalls and implement best practices.
The small financial commitment investors make upfront allows them to get to know the searchers well during the search phase, and thus better determine whether they’d like to back the searchers as operators post-acquisition.
Searchers look for companies with straightforward business models and low capital intensity, enabling them to get up to speed faster and concentrate on organic growth.
Checks and balances
Even though the searchers own the largest stake in the OpCo, investors control the board and must sign off on important decisions like add-on acquisitions and distributions.
Company owners are usually older individuals, seeking retirement without a succession plan, who have built these businesses over the course of their lives and see the searchers as the heirs they wish they had.
Searchers primarily target B2B companies in noncyclical industries to produce a larger margin of safety and mitigate their own inexperience as executives.
Aspiring searchers solicit advice from current searchers, investors, and operators, all of whom have a natural affinity for anyone considering the same unique and challenging path they all chose to pursue.
Searchers have the flexibility to customize transaction terms as the seller desires, enabling them to pay less than other would-be acquirers for the same businesses.
Lack of correlation
Target companies are so small and niche-focused that they remain insulated from many broader political and macroeconomic risks that plague public companies and large private firms.
The vast majority of searchers graduate from the world’s top business schools and choose a career that allows them to put into practice the many management skills they learned in the classroom.
HOW DOES RELAY OUTPERFORM?
RI-backed searchers enjoy more success acquiring and exiting companies than their peers.
More RI-backed searchers acquire businesses than the avg.
More RI-backed operators produce a positive IRR than the avg.
Source: 2016 Search Fund Study, Selected Observations, Stanford Graduate School of Business, 6/27/2016.
Relay Investment performance and Stanford GSB study figures are as of 12/31/15.
RI performance includes all of Martin’s and Sandro’s historical search fund investments prior to founding the firm in 2013. Past performance does not guarantee future results.