A search fund is a type of investment tool that has been functioning for more than 30 years in the USA and Canada. In Spain, this type of fund only became widespread recently. The first search fund in this country was created in 2011, and it successfully completed the acquisition of a business after almost three years. Since then, numerous search funds have arisen, and they are now in different investment stages, making Spain one of the most active countries in Europe in this matter.
A funded search is the process by which one or two entrepreneurs – with little or no experience – raise capital from various investors. They do this in order to pay their salaries and to carry out the search for a business to acquire within a period of approximately two years. In any search fund the number of investors will range from 12 to 18, and the average investment is between 300.000 and 500.000€..
Normally, entrepreneurs who head the search funds will have completed a prestigious Master’s degree or come from investment banking or strategic consultancy. In the case of the investors, we usually find former CEOs of large companies, family offices, former directors of private equity funds and, increasingly, fund of funds.
There are two stages to the investment process. During the first stage, money is invested to finance the search (paying salaries, administrative costs, travel, due diligence reports). Investors acquire the right to invest in the capital of the company or companies found. The initial capital is usually converted into company shares which have a premium of 50% of the price paid. This is to compensate the early investors.
During the second stage, the entrepreneur that heads the search becomes the General Director of the acquired company and normally receives between 20 to 30% of the capital through various tranches. In the first tranch, a third of the company shares will be held in their name. Throughout the 5-7 years of the management of the company another third of the shares will be transferred to the CEO. A further third will also be transferred to the CEO but subject to the company reaching certain investment goals (internal return rate of 30-35%).
The collaboration between the investors and the entrepreneur is one of key aspects for success and it has to be reciprocal. Usually, investors become part of the board once the acquisition is carried out. There is also an alignment of incentives amongst the different parties (investors collaborating with each other and giving support to the new CEO by helping with the lack of experience in the management of the company). The alignment of the searcher with the investors is provided by the fact that there is a success tranch received by the searcher and new CEO of the company at the disinvestment stage.
There are some existing search funds that were created to invest in one single company and, at a given moment, ended up continuing investing in more businesses (via add-ons or the acquisition of two completely separate companies).
Differences between private equities and Search Funds
The difference between a search fund and a financial sponsor or conventional private equity is that, in a search fund, since the investment is usually in one single company, the entrepreneurs become the directors of the business. On the other hand, in a conventional private equity there is a need for a management team in each acquired company. Private equity funds are created with the intention of having different companies in their portfolio and therefore diversifying risks. For this reason, a search fund is an effective alternative to selling a company if, for example, the owner is retiring or has issues regarding the succession.
30% of family businesses don’t succession plan according to a study by Centrem (“family businesses and succession planning”). 45,7% of family businesses are currently run by the first generation, 44,2% by the second, 7,4% by the third, and only 2,6% by the fourth.
The funds raised in 1983 have been invested in 200 companies in the EU and Canada. Of these 200 companies, there has been a sample of 134, with an internal return rate resulting in 34.9%.
Yields by fund type: search funds, private equity funds and venture capitals
Regarding timeframes, they are similar to those of private equities. The goal is usually to sell the company within 5-7 years.
The market niche – Low middle market
The market niche in which search funds operate in Spain means that there are few competitors. They usually invest in companies with EBITDA between 1 and 3 million, that is to say, businesses that are too big for seed capital funds or venture capitals but too small for private equities. This fact, together with the lack of an organized market, results in there being attractive target prices (between 4 – 6,5x EBITDA). Those same businesses are sold at a significantly higher multiple (up to 10 times EBITDA), when targets grow to a higher size and the buyer is a private equity or an industrial player.
On the other hand, as most companies in Spain are small and medium-sized businesses, search funds have a huge market to potentially invest in. Added to this, there is easy access to financing via debt; moreover, we are also undergoing economic change. GDP dropped by 11% in 2020, inflation has shot up recently, and in 2022 companies will begin to pay back covid debt.
Family-owned businesses in Spain
Usually, targets must meet the following requirements: a) to be within a growing market or, at least, one that is not declining b) to have been profitable over the last five years prior to the acquisition c) for sales to be recurrent with a diversified client base d) preferably, to have a low CAPEX and OPEX investment so as to support sales growth f) in addition, to have leverage capacity to boost returns.
The search is normally limited to one or two areas, but, currently, the most in demand are pharma and health, in addition to packaging. However, the investment decision is subject to a board decision, which means that the sector experience of the board plays a strong role. Logically, investors prefer sectors in which they have experience, where they can deploy and leverage their knowledge.
Search funds are not opportunistic or vulture funds. In general, they focus on solid companies with potential for growth, healthy balance sheets, and a lack of financial problems.
 Search Funds – What has made them work? Rob Jonhnson IESE Business School 2014.
 Search Funds – 2013: Selected Observations, Stanford Graduate School of Business, E-521, June 2014.
 “Family businesses make up 82.8% of the companies registered throughout Spain”. Pilot study on family businesses. INE 2016