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Edward Silva grew up wanting to be a CEO.
Mr. Silva entered Stanford Graduate School of Business in 2018 with the goal of starting his own company. “I was going to live the Stanford dream,” he said. “I was going to look for engineers. I looked for venture capital firms, and I also found technology startups.”
Then a classmate told him about another path for budding entrepreneurs. Instead of starting a company from scratch (Mr. Silva co-founded the company and was even its CEO before attending business school), he could buy the company and run it. To do that, they need to raise a “search fund,” a pool of money from investors willing to bet that ambitious young people with no track record will make money.
Silva, 34, was intrigued. “He realized he didn’t have to deal with venture capitalists who had unreasonable expectations,” he said. After raising more than $30 million in exploration funding from a small group of investors, Mr. Silva acquired his Virginia employment visa specialist consulting firm Mass Labor in July 2021. The company was the perfect target company. In his 70s and ready to retire, he had no children and only had his 15 dogs.
Search funds began as a business school experiment 40 years ago, but have grown in popularity in recent years as persuasive novices with MBA degrees lure investors into niche bets with promises of high returns. . Nearly $800 million was invested in exploration funds from 2020 to 2021, about a third of the total amount raised in such funds since the idea was floated, according to data from the Stanford Graduate School of Business. Equivalent to 1.
“At first, only a few students were interested,” said H. Irving Grousbeck, an adjunct professor at Stanford University. Mr. Grousbeck is credited with coming up with the idea for the Exploration Fund in 1984, when he was a lecturer at Harvard Business School, when Jim Southern, a student in his entrepreneurship class, founded Uniform Printing, a specialty insurance document printing company. helped raise funds for the acquisition. .
“The gym was an early success story,” Grousbeck said. According to a 2016 study on entrepreneurship by the University of Chicago Booth School of Business, Mr. Southern sold Uniform Printing Co. in 1994 after 10 years as CEO, earning a return of 24 times his investment. Obtained.
After planting the seeds of his idea at Harvard University, Mr. Grousbeck joined Stanford University, where he introduced the search fund model to generations of business school students. “Ultimately, talent, capital and opportunity came together to form a true search fund community,” he said.
Search Funding courses are now taught in nearly every major MBA program, including Northwestern University’s Kellogg School of Management and the Yale School of Management, but Stanford University remains one of the biggest promoters, with data charts It’s the only agency that consistently tracks it. Industry growth. The number of funds launched over the past decade has increased fivefold, from 20 in 2013 to 105 in 2023.
As venture capital funding declines, tech hiring cools and Wall Street salaries stagnate, search funds have proven to be an attractive way to invest, even in small amounts. The so-called average internal rate of return (the most common way investors measure the potential of an investment opportunity) for all search fund investments from 1986 to 2021 was 35%, compared to the private equity fund rate of return of 15%. % was much higher. For the past 20 years.
In the early days, investors were mostly wealthy individuals who supported young entrepreneurs, contributing hundreds of thousands to millions of dollars, but more recently, large investors, including private equity firms, have invested in search funds. I’m starting to invest in.
A typical search fund strategy looks like this: Entrepreneurs raise their first round of funding to cover their salaries and travel expenses while searching for a company to acquire. While there is no secret recipe for successful acquisitions, most companies share some key elements. The company is in a highly profitable and fragmented industry (think HVAC, home health care, waste management, etc.), and its owner is retiring without a clear successor.
Once the CEO candidate finds a target, he or she will go back to investors and try to raise a second round of financing to acquire the company. Investors and entrepreneurs benefit when the companies they acquire sell or go public at a higher price than they bought them for.
Entrepreneurial MBAs from major business schools have long been able to raise millions of dollars in start-up capital from venture capitalists, and some MBAs receive large sums immediately after earning their degrees. Search funds are used as another method of raising funds. Still, it will need to convince wary investors.
“Searchers often come out of high school and approach small businesses without having a lot of experience,” says GJ King, an investor at Search Fund.
Mr. King is looking for entrepreneurs who are humble, collaborative, and good at pitching. These three qualities, he believes, are essential to overcoming skepticism from potential sellers and their employees. Only when he is convinced of these characteristics does he decide to invest. “People will naturally be skeptical of you,” he added.
Mr. Silva, who became MassLabor’s chief executive, wrote more than 1,000 personal emails before finding the right target: a company with good financial health and an owner willing to sell. , said he made about 800 calls.
“I looked at their financials and thought, wow, we have something really special here,” he said of Mass Labor. Silva did not disclose how much he paid, except to say it was more than $33 million, more than twice the median 2021 search fund purchase price of $16.5 million.
The deal took more than five months to close and included uprooting his eight-month pregnant wife and infant from California and moving everyone to Virginia. (Mr. Silva closed his previous company, Henrite, after struggling to expand.)
As part of the transaction, Más Labor’s partner company AgWorks H2 was also acquired. Mr. Silva plans to make further acquisitions to build the business.
Acquisition-based growth strategies are gaining popularity, in part due to increased competition among both investors and searchers. Peter Kelly, a search fund investor and lecturer at Stanford University Business School, says of the industry’s emerging merger and acquisition strategy: “We’re going to grab some land and buy as many of these companies as we can and consolidate them. I will do it,” he said.
Kelsey Holland, a 2023 Harvard Business School graduate who raised exploration funding last year, said she is well aware of the increased competition. “My search was discovered,” said Holland, who worked as a product manager at companies such as Equinox before business school.
Like Mr. Silva, Mr. Holland always wanted to be the CEO of a company and thought he could achieve his goal by founding a start-up company. And in her first year at her school of business, she learned about search funds. She and her colleagues are particularly attracted to this model in the current economic climate, she said.
“If you’re involved in society, you’ve probably read about startups that you thought were doing well that are now raising capital, struggling, and cutting jobs,” she says. Told.
Holland, 33, began looking for a health care company to buy in September, raising about $500,000 from individuals and investment firms. She sent hundreds of personalized emails to business owners and met with over 20 potential sellers.
Mr. Holland said many of the executives he has met receive frequent emails from other searchers and private equity firms who are also interested in acquiring their companies. Once she finds a company, she will go meet with investors and, depending on the size of the target, she plans to raise anywhere from $10 million to $100 million.
Mr Holland said he didn’t think search funds were a surefire path to the corner office given the increasing competition in the market, but he was confident of finding the right company. “Nowadays, more creativity is required.”
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