Which is best, funded or unfunded private equity search? Private Equity Weekly

private equity search fund

Let’s say you’ve caught on to your entrepreneurial passion and are ready to give it your all. What’s next? Of course, you can build a business from the ground up if you have a great idea and the drive to do something like this. Alternatively, you could look for an existing business to buy and run. More and more people are choosing the latter as a career path, and you don’t necessarily need an MBA to do it. In this article and the next I’ll cover some of the basics required for it.

In the world of private equity, looking for businesses to acquire is called “hunting” (or deal hunting – Links to courses covering procurement strategies are provided at the bottom of this article), there are two ways to do this. The first is through funding search. This includes getting investors to put their money and trust behind you from day one. In some cases, they may simply provide a pool of capital to cover upfront search costs while retaining the right of first refusal once an acquisition target is identified. established. In other cases, investors may also invest a certain amount of capital from the outset to fund the actual transaction. Either way, your mission is to find, acquire, and help run a chosen business profitably, and then ultimately sell it so that everyone involved can (hopefully) reap the rewards.

The second type of search is an unsponsored search, also called an independent sponsor in some cases. Unfunded searches are for those who prefer to go it alone. You have more control over every step of the process, but you must also use your own resources and borrowing power to fund searches and acquisitions. This is a serious warning, as the cost of finding and working to purchase a business can often run into six figures. The only way to decide which method is best for you is to analyze in detail the pros and cons of each method and how they apply to your personal situation.

Advantages of Sponsored Search

Ideally, the investor will pay you to conduct the search, so you may not have to bear the consequences of several years of lost income even if the business is not successfully acquired. According to a 2022 Stanford Business School study (Video: oilfield | Immunohistochemistry), searchers earn a median annual salary of $120,000 (this increases to $250,000 to $270,000 for entrepreneurs who serve as CEO after the deal closes).

Investors’ money will be used to cover the (not trivial) search costs, everything from travel and travel expenses (T&E) to accountants and legal fees. The typical cost of a search (including searcher’s salary) is $425,000 (MBA rejects Google’s takeover of small company – Bloomberg).
Having investors means you can pursue bigger goals. In fact, investors may ask you to focus on businesses with EBITDA in excess of $1 million in order to make the potential absolute dollar return meaningful to them.
The likelihood of closing a deal where investor money is involved is much greater because, at least in some funded searches, the investor has already committed equity capital for the eventual business purchase, which significantly increases the searcher’s “spotlight” in the seller’s eyes. Transaction certainty”. Business owners may be less willing to take you on if they know you haven’t raised the funds needed to close.
Investors also bring non-monetary resources, such as experience, advice, and even a network of connections that may add value to the search process.

Disadvantages of Funding Search

Having an investor means giving up some level of control over the search. They may limit you to a specific industry, geographic location, or business size, while stipulating a timeframe within which the business must be acquired (usually two years).
When you find a target you like, an SBA loan may not be a financing option, although investors may be able to provide other forms of conventional (or unconventional) financing assistance. (Learn more about SBA loans here and here.)
If investors don’t like the end goal or deal you propose, they may refuse to participate.
You end up owning a smaller share of the acquired business, typically 25-35%. While you may still be the CEO, since you’re not the majority shareholder, investors generally have the power to remove you if things don’t go their way.
At some point, all investors want to get their money back, so there will likely be a timetable (usually five years) during which you will need to sell or recapitalize the acquired business.

Advantages of Unfunded Searches

In an unfunded search, you have more control and flexibility to pursue exactly the type of business you want on your own schedule.
If you don’t accept any outside equity, you may end up owning a majority stake in the acquired business, or perhaps even all of it. This has significant financial implications.If you want to delve deeper into the math involved, check out this hypothetical case big deal small business and this article on the economics of independent sponsors (Templates available for download).
As a majority or sole owner, you will have more control over the decisions of the acquired company, and you will not be fired (establishing control of the company as a minority investor).
An SBA loan can be a good financing option, although other traditional loans can be more challenging without investor backing.
Without investor surveillance, you can hold the acquired business for as long as you want. In fact, some unfunded searchers specifically look for businesses that have been owned and operated for decades.

Disadvantages of unfunded searches

Closing a deal can be tricky. Unless you have very deep personal pockets, you will typically arrange a combination of debt and equity to complete the acquisition after signing a letter of intent (LOI).
If you self-fund your search and then finance the purchase with a loan that requires a personal guarantee, such as an SBA loan, your downside risk can easily reach seven figures, between the cost of the search and the loan guarantee not mentioned The opportunity cost of the salary you might have earned. And, at the end of the day, many people, especially early in their careers, simply don’t have the cash on hand to give up a salary and spend six figures to “maybe” acquire a business.

How about a hybrid?

For those who have a hard time deciding which type of search is right, there is no ironclad barrier between the two. For example, some fund their own searches but hire investors to make acquisitions. As with any deal involving investors, issues such as ownership percentages and exit timelines depend on the nature of the negotiations and the investors brought in. Decision-making may be easier if there are only one or two people, but it may also require more compromise on the part of the searcher. In a more diverse investor base, consensus may be harder to come by, but if each investor’s share (and power) is more diluted, searchers may actually get more “pull.”

Private equity hunting is an epic undertaking

Ultimately, the best type of search depends on individual circumstances. Younger, less experienced people without significant personal savings may be attracted to funding options. But getting investors to commit money isn’t easy. They often prefer credentials such as an MBA from a top school and/or past experience with a reputable bank, investment fund or management consultancy firm.

Technically, unfunded searchers can come from any background as long as they can direct the necessary resources. But it’s not a piece of cake either. One of my friends in the industry even said, “Honestly, I wouldn’t recommend self-funding unless you have independent wealth or a spouse or partner who can easily support you both for at least a few years.” I’d like to add that, in general, There are exceptions. After all, there are all kinds of searches, including those for relatively affordable businesses on a tight budget (see the video below for a crazy example). But the financial needs of any unfunded search should be carefully considered before committing.

No matter which path you take, think of your private equity search as an epic journey by the hero (you) to achieve your goals. Such journeys form the basis of many of the most exciting stories. Hope your private equity search becomes one of these. But before we continue, stay tuned for the next article where I will go into more detail about the daily life of a searcher, with or without funding.

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