5 min read · Jun 28, 2019
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After a couple of inquiries and confusion about Clarendon’s Succession/Acquisition Search engagement (Clarendon Search Partners), I want to explain Search Funds to those who are unfamiliar.
A search fund is an equity capital commitment and an individual looking (searching, hence the name) to acquire an existing business.
A key element is that search funds “provide capital access for promising managers to become entrepreneurs through acquisition” — Wikipedia. The difference between an acquisition and a succession is the timing of the transfer of ownership and executive responsibility, where an acquisition would happen immediately, a succession is over time — possibly years. While less typical, a search fund could include more than one team members or capital commitments besides equity (e.g., a loan or mezzanine financing).
A search fund can be organized as a partnership to benefit from certain tax advantages. This partnership capital can be raised and sit in escrow or pledged for payment once a letter of intent (LOI) is accepted. Having the cash sitting ready can make the search fund more credible, more attractive as a suitor to the seller, and speed up the closing process (don’t have to wait for LPs to wire funds). My preference is a pledge fund/pledge structure. With this, the LP can decide if they agree with the entrepreneur’s specific acquisition opportunity and plan. Pledging capital does not keep LP capital tied up (possibly for years) earning a meager savings account yield. Or worse, a deal may never be completed, and the capital was “dead money.” Additionally, with a pledge structure, it allows for flexibility in the ultimate capital contribution given the specific deal reached — reduce search fund capital, or a different capital/deal structure could be appropriate. Some search fund entrepreneurs who devote themselves 100% to working on the search may seek a salary and expenses born by themselves and the partners — I am against this practice since a deal may never happen. To reward the entrepreneur’s effort of completing a transaction, they may be given additional equity interest, between 0 and 20%.
The two most critical elements of a search fund are the entrepreneur (or team) and the acquisition thesis/target characteristics. The entrepreneur will…
