The Best Performing Private Investment Segment? Search Funds!

When you look at the performance data tracked over the last 20+ years, no other investment segment generates average returns of close to 3.0x and IRRs of close to 30 percent (‘2020 Search Fund Study: Selected Observations’ – Stanford GSB).

So, what are Search Funds? And, why do the ‘Over- Perform?’

 They are investment vehicles usually formed by young entrepreneurs who, after receiving their MBAs, at some point, decide that they are most excited about running a business. They raise a relatively small pool of capital that gives them financing to sustain their efforts while they search for a business for a period of roughly 2 years. When they find such company (about 2 out of 3 do so), their investors have the right, but not the obligation, to invest their pro-rata share in the acquisition entity. In essence, investors back relatively inexperienced managers as they embark on a process of running a company. So, why does it work so well? Three key reasons stand out.

First, what search funders lack in experience, they more than make-up in talent and motivation. They are highly accomplished and highly motivated, with all the good personal qualities that usually come with them. Second, they draw on the collective experience of their investors, who often become their coaches, mentors and business advisors. Lastly, they operate in relatively (still) inefficient markets for smaller ‘under the radar’ companies, where competition is much less intense or not present at all.

These three drivers have been around since search funds’ inception (in the ‘80s). They are likely to continue to be there for the years to come. From an investor’s perspective, there are still other very important factors that contribute to the overall attractiveness of this investment class.  Several of these factors are relatively new – and quite important to understand as the ‘Search Fund’ Game continues to evolve.  We will elaborate on them in our next issue.