In this first paper of 2022 we are going to talk about the Search Funds. A product that is spreading rapidly in our market, Search Funds started in the United States more than a decade ago. We are talking about an instrument through which one or several young entrepreneurs, with some business experience, decide to join efforts and raise capital for the acquisition of a company. A fundamental difference emerges here from investment funds, a collective investment institution but where the entrepreneur or “Searcher” leads the project under the figure of CEO of the acquired company.

How do they work?

The Searcher of a search fund, thanks to his academic background and professional capacity, receives a minimum initial capital from between 15 and 20 independent investors, and also from investment funds. Normally, the initial investment should be sufficient to cover both their salary and other management expenses necessary to carry out the search for the target company. Typically, the maximum search time is approximately two years. During this period, investors have the commitment, but not the obligation, to invest in the identified company.

A key quality in the expertise of a Searcher is to know how to surround himself with investors with relevant backgrounds in the fields of action of the company being suoght to invest into. It is essential that these investors can bring business, technical, sectorial knowledge and/or contacts to the target.

The target companies of Search Funds are usually small and medium-sized companies, included in the so-called “Middle Market”. With a turnover of between 5 and 50 million euros, these companies are off the radar of the relevant investment funds or large strategic buyers. They are usually companies without a defined growth plan – or with succession problems – operating in sectors with few fluctuations and low technological risk.

Criteria, investment process and objectives

There are no strict criteria when choosing the target company for investment. Thus, we can find Search Funds interested in technology companies or, simply, in companies where the current partners or shareholders want to make cash and gradually leave their day-to-day management of the company. From this point on, investment criteria are usually agreed upon with all investors.

Another fundamental element when deciding to invest in a target company is that the company must prove, clearly and through precise documentation, that it is in a solid financial situation capable of generating attractive returns for investors. They must be companies with a simple business model, recurring revenues and a diversified client portfolio. For all these reasons, companies with problems or operating in declining sectors are not suitable for this investment profile.

The acquisition of the company is usually financed with contributions from the partners and bank debt. Debt never exceeds 50% or 60% of the total investment, but is necessary to improve expectations of future returns. Partners who ultimately do not invest, usually sell their shares and leave the Search Fund.

It is the company incorporated as the Search Fund that acquires the total shares of the target company. In the event that it is agreed that the owners of the acquired company retain part of the shares or participations, they will keep them in the Search Fund company and not in the target company.

The capital invested by the Search Funds is usually converted into shares of the acquired company at a 50% premium to the acquisition value of the other investors. This strategy seeks to compensate the promoters of the Search Fund for the risk assumed by financing the project. It is usual that, if one of the investors does not want to buy into the company because he does not find the investment attractive, he is also rewarded with a 50% return on the capital he has invested. The investor only loses the money in the first phase, when the Searcher does not manage to find a company to buy.

From the study of different statistics we know that Searchers filter between 2,500 and 3,500 companies, analyze between 300 and 500, talk with between 100 and 120 owners, sign approximately 40 to 50 confidentiality agreements for the in-depth analysis of the companies and make between three and five offers for those companies that they consider really interesting and in line with their strategic objectives.

Life cycle of a Search Fund

The life cycle of a Search Fund generally consists of the following phases.

  1. Raising initial capital from the selected package of investors.
  2. Search and selection of targets.
  3. Target acquisition process (due diligence, valuation, negotiation, legal process and signing of the Share Purchase Agreement or “SPA”).
  4. Implementation of the growth plan..
  5. Exit of the capital after several years managing the company. Normally the exit culminates in a sale to a private equity firm or stock market listing on a local or international market – two examples are the Spanish “BME Growth” (formerly known as “Mercado Alternativo Bursátil” or “MAB”) or “Euronext Access Paris”.

Keys to success

The essential elements of success of the Search Fund as an investment vehicle are:
  1. Providing an advantage over traditional models of sale to investment funds, as there is not necessarily a requirement for a sale in the short term. This reduces the pressure at the moment of achieving the objectives set, an element that is highly valued in the type of target company that is the main focus of Search Fund operations in Spain.
  2. Developing a good understanding between the seller and the Searcher, as the permanence of the current partners for at least a couple of years is an essential condition.
  3. There is no majority shareholder, consequently the composition of the board of directors is key to the success of the project.

How ECOVIS can help you

If you are a seller

Our work methodology allows us to obtain quality information on the value of your business, the analysis of the market and your competitors; the preparation and defense of vendor due diligence reports; the search for quality buyers and the defense of your interests. Our support will be equally provided in German, English or Spanish, depending on your needs, and always in the form of turnkey solutions throughout the entire transaction.

We have a worldwide network of contacts in more than 80 countries and more than 9,000 professionals, which gives us access to competitors, private equity, search funds, private investors and family offices interested in listening to new investment proposals.

If you are a buyer, whether private investor, search fund or private equity

Our offices around the world detect, on a daily basis, new investment opportunities in strategic sectors, different business formats and investment formulas adapted to your needs. At the same time, at the local level, we work with more than 200 clients and 50 related partner organizations that provide a very broad map of contacts on which to locate quality targets.

Our teams of professionals in the economic-financial, fiscal, legal, labor and strategic fields will accompany you in the required language throughout the process of analysis, target valuation, management of Virtual Data Rooms in due diligence processes, market analysis for the search of the optimal target and as support in the negotiation of the purchase. Our job, for you and your money, will be to obtain the best price conditions and payment formula in your acquisition transaction.

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