PP Alert July 2013 (2): Search Fund and business acquisition
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Alert: Search Fund - a 'try before you buy' acquisition model

The search fund concept emanates from the US and has been around since 1984.  However, this is an unexplored model in Australia and it is one that can play a part in the Australian business exit landscape. 
The search fund is in essence a two stage acquisition vehicle composed of the search sponsor and its participating investors.  In the first round, the search sponsor, who generally would be an entrepreneur or a previous C-level executive, would raise a small round of capital that would fund the search and due diligence work of the search sponsor for a certain period of time (generally over two years) by setting up a search fund and outlining all the relevant requirements (including term of the fund, investment criteria, search methodology and step-up acquisition participation).  

Once the search sponsor has identified an ideal acquisition opportunity that meets the investment criteria of the search fund, the search sponsor would seek to raise further capital from its participating investors to fund the equity component of the acquisition price of the business.  The participating investors have the right, but not the obligation, to form part of the acquisition consortium.  The participating investors would assess the investment opportunity on its merits.  If they choose to participate in the acquisition, there is a step-up mechanism that will inflate their contribution due to their first round capital involvement.  Post-acquisition, the search sponsor would take charge of the business with the aim to increase the value of business and ultimately exiting.
There are numerous benefits for using a search fund model to spearhead an acquisition, including:
  • It provides the participating investors and the search sponsor with a honeymoon period, being the search period, where they can understand the dynamics of and develop their relationship.  This is critical for the second investment phase;
  • It also provides the participating investors with the opportunity to assess the capabilities of the search sponsor prior to committing a substantially larger investment in the second round;
  • Search sponsor can use the participating investors as a sounding board and leverage off their expertise during the search period and the investment holding period;
  • There is some form of certainty for the search sponsor that equity funding can be sourced from the participating investors where the right investment has been identified and the search sponsor has secured the confidence of the investors over the search period; and
  • This model allows the search sponsor to fully commit to the search fund and explore the deal flow pipeline. 
Essentially, this model is a mini replica of a private equity fund undertaken on a single deal basis with the search sponsor taking charge of the operations post the investment. This model can certainly fit in the Australian business space and can provide a means through which baby boomers can realise their exit.
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