Search Funds
Search Funds are vehicles for entrepreneurs to raise funds from investors interested in making private equity investments, and to use those funds to search for, identify, acquire, and ultimately operate an existing privately held company.
Stage One
In the first stage, a small group of investors back the fund manager’s search for a target company to acquire. As an incentive, first round investors often receive a step-up of their initial investment if a target company is identified and acquired.
Stage Two
Once a target company is identified, first stage investors have the opportunity to invest an additional amount (up to their pro-rata ownership percentage) to acquire the target company. Once the acquisition is complete, the manager(s) becomes the CEO of the acquired company and receives a significant equity ownership interest in the venture.
Target Company Profile
Search Funds typically target companies that are in the $5 million to $30 million price range, operate in fragmented industries, have sustainable market positions, have histories of stable cash flows, and provide long term opportunities for improvement and growth. Service and light manufacturing companies outside high tech industries are popular targets. These companies are often under-managed prior to the acquisition.
Entrepreneur Profile
Most Search Funds are started by entrepreneurs with limited operational experience and possibly no direct experience in the target company’s industry. The goal of Search Fund investors is to place promising, motivated managers in an environment with a high probability for success given the oversight and experience of the investor group.
History
The origins of the Search Fund are often traced back to H. Irving Grousbeck, a professor at Stanford University’s Graduate School of Business, who originated the concept in 1984. Since then, it is estimated that over 100 funds have been formed. The bulk of successful Search Funds have been raised by alumni of elite MBA programs with access to strong private equity networks (e.g., Harvard, Wharton and Stanford).
How Can We Help?
Our search fund team has considerable experience advising Search Funds from the start to finish of this process, including attorneys with specialties in tax, employee benefits, lending, real estate, intellectual property, and environmental law.
Formation:
We work closely with our Search Fund clients early on to form the fund and finance their first stage capital needs, including:
- Preparing and filing the necessary documentation to form the entity
- Identifying investors willing to commit to providing the funds initial capital needs
- Negotiating financing terms with investors, including the preparation of the fund’s formal operating agreement
- Preparing the necessary documentation for the fund’s securities offering to its investors, including subscription agreements and any required federal and state securities filings
Search:
During the search phase of the process, we help guide the Search Fund manager through the process of successfully negotiating with prospective sellers, lenders and investors, including:
- Negotiating key business terms with sellers via letters of intent
- Negotiating fair and manageable terms with senior and/or mezzanine lenders in commitment letters
- Amending or restating the fund’s operating agreement to reflect changes in the business deal with original and/or new fund investors in anticipation of the acquisition
Acquisition:
Once the fund has identified the target company and its funding for the acquisition, we work with opposing counsel and the fund’s lenders and/or investors to finalize the business terms of the transaction and then execute and close the acquisition, including:
- Drafting and negotiating the acquisition documents, such as the purchase agreement, escrow agreements, consulting agreements, employment agreements, non-competition agreements, transition services agreements, seller notes and opinions of counsel
- Negotiating the loan documentation with the fund’s senior or mezzanine lenders and/or its investors, including loan agreements, guaranties, notes, subordination agreements, security agreements and warrants
- Negotiating the real estate purchase or lease documentation with the target company, including purchase agreements, lease agreements or licenses, escrow agreements, indemnity agreements, mortgages, surveys, environmental reports and title insurance
- Identification of tax concerns and tax planning related to the structures and methods to be used to purchase the target company
Operation:
After the acquisition is made, we continue to assist the Search Fund in ensuring a smooth operational transition of the company; handling any indemnification claims that arise between the parties; and addressing all of the company’s general corporate legal needs on an ongoing basis.
Disposition:
Most search funds are established with a long-term outlook, often no less than a three to five year time horizon. When the time is right, however, liquidity events for investors and managers will occur in the same manner they typically occur for equity-holders of any privately held company via merger, asset sale or stock sale. We have extensive experience in representing privately-held companies in these types of liquidity events and can assist the search fund in all aspects of marketing the company for sale, negotiating the terms of sale of the company and successfully closing the transaction.
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