IN 2007 Lucas Braun and Ryan Robinson emerged from the Stanford Graduate School of Business with such a sense of “professional invincibility” that they decided not to return to their old jobs in a consultancy and a hedge fund, respectively. Instead the two Americans took a leap of faith—in themselves.
They were 32 and had no experience of running businesses, but they persuaded a group of investors to finance them for 21 months as they searched for a business to acquire. They discovered OnRamp, a Texas-based private company, and assumed the roles of chief executive and chairman. Following spin-offs and acquisitions, the company now provides cloud computing for industries with sensitive data. Over the past seven years, they say, revenues have grown by 30-35% a year.
The two executives are products of a niche of the private-equity industry known as search funds—such a small niche, in fact, that few in the business have heard of it. But Stanford, which helped pioneer the industry in the 1980s, tracks it, and says that it has grown sharply in the past two years. In 2015 more than 40 new funds were established, twice as many as in 2009. Over the same period the number of acquisitions made by these funds tripled, to more than 15 a year.
The typical search-fund principals are MBA graduates from an elite American university, who raise $400,000 or so of “walking around money” from investors, who purchase a stake in the fund for about $40,000 a share. The fund searches for a high-growth, high-margin target, valued at $5m-20m. The fledgling businessmen then hold a second round of acquisition financing, as well as raising debt. Their tenure as bosses lasts until they sell out.
Returns are surprisingly good. The average is 8.4 times the money invested and an internal rate of about 37%. They do much better than the average of the rest of the private-equity industry, analysts say. By the time of the exit the principals can hold a 30% equity stake, provided they have met their targets. That is not a bad deal for a no-money-down entrepreneur.
Some firms are injecting scale into the business. Boston-based Pacific Lake Partners, for instance, is dedicated to investing in search funds, and gives firm guidance regarding the industries and regions it prefers. Timothy Bovard, an industry expert, founded an incubator called Search Fund Accelerator in 2015 that provides capital and mentoring to aspiring search-fund entrepreneurs, in exchange for equity. Increasingly, the business is cherry-picking best practices from other bits of private equity. But the funds never invest in a portfolio of firms. Instead, the years knocking on doors can lead to a visceral sense of commitment to the targeted business.
For several decades, America and Canada were the sole home of search funds. But lately European MBA courses have included search-fund case studies that have whetted the appetite of some intrepid would-be entrepreneurs. There are plenty of reasons for caution, though. About a quarter of searches come to nothing, and about a third of the acquisitions end in failure. But that is still better odds than starting a business from scratch.