Trade buyers and private equity have been the traditional acquirers of businesses in Australia, but search funds are increasing in popularity across the corporate finance landscape, particularly for transactions less than $50 million.
Search funds can potentially widen the pool of buyers for a business but these funds are attracted to specific features that boards and founders should be aware of if they wish to make themselves an eye-catching target.
But first, what is a search fund?
A type of private investment vehicle, a search fund allows an entrepreneur (known as a ‘searcher’) to acquire and operate a business.
The search fund model was originally developed in the United States more than 40 years ago but it has gained popularity in the Australian market over the last few years.
There are generally two types of searchers – those funded by investors and self-funded individuals.
In the funded model, the searcher is paid by investors as a search is conducted, although the salary in minimal, typically only covering day-to-day expenses.
Self-funded searchers finance themselves through the search phase and the wider pool of investors becomes involved in funding the acquisition once the target company is found.
Either way, the searcher is motivated by the potential of a business and the opportunity of running day-to-day operations of an acquired company as the chief executive officer (CEO) or general manager (GM).
In Australia, searchers commonly look at the smaller end of the acquisition landscape, favouring transactions up to around $50 million in value, and operations with at least $2 million in earnings before interest, tax, depreciation, and amortisation (EBITDA).
When a suitable company is identified and the acquisition is finalised, the investors in the search fund will own most of the equity in the business, and the searcher is usually appointed as the new CEO or GM and generally owns a small percentage of equity. Shareholders receive ongoing dividend payments as long-term holders of the business.
One option is to sell the business outright to the search fund and searcher, meaning that the searcher takes full charge of ongoing operations and the owner can exit the business entirely.
Another option is for existing owners to partner with the fund and searcher and retain a minority stake in the business, which may be a useful option for owners looking to diversify their holdings, maintain some level of involvement in the business and access capital that may not otherwise be available.
Unlike the traditional private equity model which requires a future exit event within three to five years, a search fund is typically a long-term holder of a business, which can provide surety to the seller and the business’s employees.
In Australia, searchers favour transactions of up to $50 million involving private businesses in good financial health, harbouring limited risk and with a strong track record of annual EBITDA of at least $2 million.
A favourite target of search funds is well-run family businesses managed by people seeking to retire or simply move on from running day-to-day operations.
Each searcher will have a different goal in mind but there are some consistent themes that make a business an attractive prospect. This includes:
Searchers will look for opportunities to increase efficiency in getting a product or service to market, or examine where prices can be increased without significantly impacting demand to enhance future returns.
The search fund model is not without risk and business owners should have a clear understanding of what a searcher is looking for and what they want out of a transaction.
If a business owner is approached or is considering negotiating with a searcher, a thorough vetting and due diligence process is critical before any paperwork is signed.
Searchers reach out to hundreds of companies and often know very little about them when they do make contact. While many are highly educated and armed with MBAs, others have limited or no operational track record in running a business.
Searchers and search funds are not typically big payers for a business, and it may be that a trade buyer is prepared to pay more in a traditional M&A transaction that unlocks synergies with an existing business.
But in some cases, search funds can provide an alternative to traditional buyers of businesses and should form part of succession planning considerations.
A good search fund can be a long-term business investor who will provide continuity, peace of mind for clients and customers, and reassurance for employees and stakeholders.
Andy Hough leads Pitcher Partners M&A team in Sydney.
Andy Hough leads Pitcher Partners M&A team in Sydney, predominately advising clients on the sale of their businesses. Prior to joining Pitcher Partners in August 2021, Andy spent 20 years in the big four, including time spent working in an internal M&A team, where he was involved in over 15 professional services transactions in Australia and the broader Asia-Pacific region.
