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.
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.
- Limited financial downside.
- Less control
- You get the experience and gain the credibility of running a much bigger business.
- You can benefit from the experience of your investors.
- 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.