A search fund typically has a dedicated group of professional investors who manage it all on behalf of the investors. Unlike traditional VC funds, these professionals have an entrepreneurial background and experience in the sector they invest in. As such, they are able to provide invaluable advice to their portfolio companies as well as assist with managerial expertise and networks for further funding rounds from other sources. These professional managers usually possess considerable industry knowledge from their own experience as well as from other investment ventures that they have been involved with. Fund managers of search funds are also more likely to have a larger personal stake in the fund they manage due to the fact that they are directly involved in making investment decisions through their own money.
Search funds are usually set up by institutional investors that are looking for a new way to diversify their portfolio, or by wealthy investors who want direct access to specific types of investments. These types of funds require considerable amounts of capital, often over US$50 million, but can be worth it given the potentially high returns. They offer significant advantages over normal venture capital firms in terms of speed and flexibility. Fund managers tend to move fast when opportunities arise while also being able to pull the plug on failing ventures.
The kind of investments search funds make typically includes small and medium-sized enterprises in the technology and life sciences sectors that regular venture capital funds may not be able to reach due to their high level of specialization. However, in general search funds tend to invest at earlier stages than traditional venture capital funds, making them riskier in nature. Other types of investments made by search funds include distressed situations and others typically considered unattractive by other types of investors. Along with this, search fund managers are less inclined towards quick exits but are more focused on building up companies for long term success.
Typically, search fund managers will not have any prior experience working together, but instead work together temporarily due to their expertise in specific industries or geographical regions. Therefore, the search fund manager has to create a system that allows them to avoid being hindered by colleagues.
The creation of a search fund is relatively recent. In the beginning, search funds were only considered as a subsidiary type of venture capital firms. However, as technology became more sophisticated it permitted much more flexible and efficient investment opportunities to arise. For this reason, search funds have become increasingly important in the private equity market over the last decade, and it is no surprise that they have now become one of the most sought-after types of investment funds in high-tech sectors.
Process of setting up a search Fund
Typically the process of setting up a search fund involves three steps:
- Approval of the deal by the portfolio company’s management
2. Initial research on market attractiveness
3. Investment decision
STEP 1: Approval of the deal by the portfolio company’s management. The search fund manager prepares a proposition to the portfolio company’s management stating that there is significant potential for future growth. The proposition will include projections outlining both positive and negative impacts on each of the shareholders, both individually and as a whole; investors; search fund; and project team, as well as an outline of potential future revenues. This will be sent to all shareholders (both individuals with whole-share ownership and institutional investors with partial ownership) along with instructions on how they can vote.
STEP 2: Initial research of market attractiveness. Once the search fund manager receives approval for their proposition, they carry out extensive research of the sector in which the portfolio company operates. Their objective is to find potential areas in which they might be able to make investments; they will typically carry out research on companies in each sector, taking note of what makes them special, any potential weaknesses (such as size, competition, etc.), and finding out what other investors are currently putting their money into this industry.
STEP 3: Investment decision Once the search fund manager has completed this phase of their research, they will approach their investors with an outline of options for investment (either buying shares or making a loan). They will outline the advantages of both options, as well as the risks involved. In some cases it may be possible for the portfolio company to borrow from bank sources, but more often it will be necessary to look for alternative sources of funding from the search fund manager’s managed funds or from other investors within the fund.
In return for investing money into a search fund, investors expect:
Search funds can be different in size and structure depending on their primary investor and type of investment they seek to make. For example:
Search funds may also invest in alternative sources of capital such as securitisation and equity finders. This is usually achieved by investors engaging a company who will use their contacts to identify suitable investment opportunities.