What is a Search Fund and How Does it Work?
A search fund is a private investment fund that entrepreneurs use when they want to acquire a small business. Once the small business is taken over, the entrepreneur will likely become its president or CEO.
Read the rest of this article to explore how search funds work, including their key terms, and how consulting a lawyer for guidance with the process can streamline it while minimizing your risks.
What are Key Terms in a Search Fund?
A search fund usually includes the following essential terms.
- Searcher. This is the term for the search fund entrepreneur who will raise capital to find a business to acquire.
- Investment vehicle. This is the legal entity structure, such as a limited partnership (LP), that’s established to hold the raised capital and buy the business.
- Investors. These are the individuals or companies who are raising capital and giving it to the search fund.
- Target company. This is the small or medium-sized business that will be acquired.
- Value creation. This is the term for how the company will find ways to help the small business, such as by improving its operations.
- Vesting schedule. The searcher earns a share of equity in exchange for finding and operating the target company.
How Does a Search Fund Work?
The following activities are usually involved in the process of search funds.
Raising Capital
A search fund manager raises capital. This money is usually derived from other investors or entrepreneurs in their network. There can be a few or multiple investors, depending on the amount the search fund is trying to raise. In some cases, it can be a few million dollars.
Finding a Company
While raising capital, the company will start searching for a small business candidate they want to acquire. Potential companies will be scrutinized and researched. It’s common for companies to search for businesses that have good growth potential and a strong revenue. The search can take a few months to a few years.
Typically, this phase of the process involves the following:
- Evaluating the company. This is an initial review of the company to see if it’s a suitable option.
- Drafting a letter of intent. This document is a term sheet that states the company’s intent and outlines the deal terms.
- Due diligence. This is a deeper review of the small business’s structure and financial wellbeing.
Growing the Company
Once the business is acquired, the company will find ways to enhance its growth, such as with various financial strategies. This is a big investment because it’s common for companies to run the business for many years, sometimes up to a decade.
Investment Exit
After the duration of running the business comes to an end, the fund manager will make an exit. This is usually triggered by an event, after which the original fund investors will be paid out in returns.
What are Pros and Cons of Search Funds?
There are various pros and cons associated with search funds. Here are some to consider.
Pros
- The search fund entrepreneur is invested in running the small business, which can significantly assist its growth.
- By acquiring a business that has a good track record and healthy finances, this can minimize the high risks that are usually associated with startup companies.
- There’s the potential for strong returns.
Cons
- Search funds can take a long time to set up, especially during the business acquisition phase.
- Search funds are usually niche, so there might be a smaller pool of investors.
How Does a Lawyer Assist with Search Funds?
A lawyer is an important professional to work with when setting up a search fund. This is because the process can be time-consuming and require expertise, while involving a range of activities, such as acquisitions, contracts, and legal compliance.
Here are some things that lawyers can do to help you with search funds:
- During the fund formation, a lawyer will set up the fund’s legal structure so that it suits your business goals.
- Drafting and/or reviewing essential documents you require, such as investor agreements, ensures their terms are clear and legally sound.
- During the fundraising stage, lawyers check for compliance with all laws and regulations.
- Lawyers will help the search fund during the business acquisition process, such as by conducting due diligence.
- They can negotiate with investors on your behalf.
- After the acquisition process, lawyers help you with ongoing regulatory compliance.
Where to Find a Lawyer for Search Funds
If you need legal guidance with search funds, you should hire a lawyer from an online legal platform. On ContractsCounsel, an online legal marketplace, you’ll connect with vetted lawyers who have experience in assisting people with setting up and managing search funds.
You can search for lawyers based on data provided by the platform, such as their credentials and previous projects that they’ve completed on the platform.
You can also hire a lawyer to draft or review documents required throughout the search fund process. To do so, follow these simple steps:
1. Go to the ContractsCounsel marketplace.
2. Post your project (or request) for free. Include some details about what you need as this will help you connect with the most suitable lawyers.
3. You’ll receive multiple bids from lawyers directly on the platform who have the experience to assist you.
4. Once you receive the lawyer bids, you can review the lawyers' profiles. There’s lots of info on the platform to help you choose the best lawyer, such as their location, client ratings, years of experience, and field of expertise.
5. Connect with a lawyer you think is best suited to your requirements and hire them.
6. Alternatively, you can also request an online legal chat with a qualified lawyer.
