In the dynamic real economy investment landscape, the search fund model offers a unique opportunity for investors seeking to identify and grow promising small and medium-sized enterprises (SMEs). As an innovative and increasingly popular investment vehicle, the search fund model presents a blend of high potential rewards and strategic risks.
Originating in the US in the late 1980s, search funds are a particular private equity investment vehicle that allows an entrepreneur (the searcher) to acquire, manage and grow an existing SME with significant potential.
Unlike traditional private equity funds, search funds focus on a single acquisition, allowing attention and resources to be concentrated on the acquired company.
Crucial in the search fund is the figure of the searcher, often a former strategic consultant specialised in merger acquisition transactions, corporate restructuring or a private equity expert, who, thanks to the financing of a group of investors, searches for an SME to acquire and take over its operational management. After acquiring the target SME, the searcher undertakes to grow the company and then sell the stake to strategic or financial investors, realising an exit with positive multiples compared to the capital invested.
A search fund is structured in two main phases:
- Search phase: The searcher raises capital from investors to finance the search period for a company to be acquired, which can last between 12 and 24 months. During this phase, the searcher identifies and evaluates SMEs in sectors with strong growth potential and scope for operational and management improvement.
- Acquisition and management phase (acquisition phase): Once the target company has been identified, the searcher raises additional capital from investors to finance the acquisition. Subsequently, the searcher assumes the role of CEO, optimises the operational management of the company, increases revenue and EBITDA and creates value in view of the target exit. The average investment horizon is about 5-10 years
Originating within the Stanford Graduate School of Business, the search fund model then spread globally, especially in Europe and Latin America in the 2000s and 2010s.
In the US, the search fund is a well-established model thanks to entities such as Relay Investments, one of the world’s best-known investment groups, founded by two former searchers with successful track records, which has financed more than 100 search funds worldwide, or Trilogy Search Partners and Pacific Lake Partners, both with investments in more than 200 search funds.
In Europe, the search fund model is relatively newer than in the US, but is growing rapidly, especially in countries such as Spain (Seaya Ventures, Inveready, Wayra Search Fund), France (Brighteye Ventures), Germany (Ambit Partners) and Switzerland (Novastone Capital Advisors).
In Italy, search funds are a relatively new model compared to the US and other parts of Europe, but they are gaining in popularity due to the presence of a large number of small and medium-sized companies, many of which are in generational transition. This creates opportunities for searchers to take over and grow established companies with upside potential and has prompted many private equity funds to create a dedicated search fund division. This is a choice shared by Clessidra, Peninsula Capital and Pharus Group, which stand alongside companies more specifically dedicated to supporting search funds such as Search Fund Italy (SFI) and Argo Capital.
The search fund model represents an attractive investment opportunity mainly because of the potential for high returns.
Search funds have demonstrated the ability to generate impressive returns for investors. By focusing on niche markets and undercapitalised sectors, searchers can unlock significant value, leading to attractive internal rates of return (IRRs) and multiples on invested capital.
Data on search fund returns vary by region (source: International Search Funds)
- In the US, search funds have historically generated an average return on investment (IRR) between 30% and 40%, with exit multiples ranging from 3x to 6x the invested capital.
- In Europe, the most established search funds reported IRRs of between 20% and 30%, with average exit multiples of 2x-4x.
- In Italy, as the model is still under development, there is less data available than in the US, however, Italian search funds target IRRs of 20%-25% and multiples of 2x-3x.
One of the main strengths of the search fund model is then the alignment of interests between searchers and investors. Searchers often receive a significant equity stake in the acquired company, ensuring that their success is directly linked to the company’s performance.
Search funds also provide investors with access to high-quality, carefully vetted investment opportunities. The due diligence process undertaken by search funds is rigorous, ensuring that only the most promising targets are pursued. Unlike traditional private equity investments, where investors may have limited involvement, search funds offer a higher level of control and active participation. Investors have the opportunity to guide and support searchers throughout the acquisition process and beyond.
Of course, there are risks associated with the model, in particular: the initial search phase can be long and uncertain. Searchers typically take 12-24 months to identify a suitable acquisition target. During this period, there is no guarantee of success and investors must be prepared for the possibility of long lead times and potential delays.
Once an acquisition has been made, the success of the search fund depends heavily on the ability of the searchers to effectively manage and grow the acquired company. Operational challenges, market changes and unforeseen obstacles may impact performance. Moreover, due to the single-company focus of search funds, there is an inherent risk of limited diversification. Unlike traditional private equity funds that spread the risk across multiple investments, search funds concentrate capital in a single asset, (somewhat like SPACs but involving IPOs, ed.) increasing exposure to company-specific risks. (photo by Mike Kononov on Unsplash)
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