A search fund versus skin in the game

A search fund versus skin in the game

Money | Posted by YouInc.com - June 6, 2013 at 2:42 pm

Photo: Rob Cherun manages strategy, finances, and operations at UCIT Online Security. His investment firm, Auxo Management, purchased a stake in UCIT in April, 2011.

Friends and fellow Ivey School of Business grads, Erik Mikkelsen and Rob Cherun, own Auxo Management, a successful search fund and part of a movement that's coming to Canada.

Other search funds I've encountered have been started by smart business school graduates who have some finance experience - private equity or investment banking - or a management consulting background. They find a group of about 20 high-net-worth investors who help fund an acquisition search. The small investment, say $500,000, while they hunt for a company to purchase is then used to pay for office space, salaries for the founders, and diligence costs.

There is typically a finite amount of time, maybe two years, allocated to find a business to buy. Assuming there's a purchase, the original backers have first rights of refusal to invest in the deal. The search-firm founders receive about 10-per-cent equity, a market salary (in the neighbourhood of $100,000 to $250,000), and a bonus structure based on increases to the enterprise's value. They later hope to divest the company.

Here's a simplified example:

If a search fund buys a business for $10 million and uses $5 million in debt to acquire the company, investors will need to come up with $5 million in equity to close the deal. Each founder hypothetically gets a "free" $500,000 valuation on closing (10% x $5M in equity = $500K). If the debt is paid off four years later and the business is sold – assuming the company didn't grow – each of the founders would make $1 million in proceeds. If they each get a 5-per-cent bonus, they'll make $1.5 million. And there's no financial down side.

Sounds like a great deal to me!

Compare this to the path I took:

I used my student line-of-credit to start Hennessey Events Inc., and I maxed out my credit cards. I started and built it on my own. I later used all of my earnings to buy a manufacturing business called RoyalPak. I have personally guaranteed every bank loan I've had to date.

Here are the pros and cons of using a search fund for an acquisition, or your own money.

Search fund:

Self-funded company:

  • You have control.
  • You may have an emotional tie to the business.
  • If you decide to accept external investment later on, you may be able to maintain a significant equity piece.
  • External equity is attractive to investors because you have skin in the game and you have operating experience.

Tags: money, investors, billy hennessey, schedule, fund, control, business, entrepreneur