Young entrepreneurs find a way to make their CEO dreams come true
Edward Silva grew up wanting to become a CEO.
In 2018, Mr. Silva enrolled in the Stanford Graduate School of Business with the goal of starting his own business. “I was going to live the Stanford dream,” he said. “I started looking for an engineer – we went looking for a venture capital firm and a technology start-up.”
Then a classmate told him about a different path for aspiring entrepreneurs. Instead of starting a company from scratch — Mr. Silva had co-founded and even served as CEO before business school — he could buy one and run it. To do that, he would have to raise a “search fund,” a collection of money from investors willing to bet that an ambitious young person with no track record will make them money.
Mr. Silva, 34, was intrigued. “I realized you don’t have to deal with VCs that have unreasonable expectations,” he said. After raising a search fund of more than $30 million from a small group of investors, Mr. Silva in July 2021 purchased MásLabor, a Virginia-based consultancy specializing in employment visas. It was the perfect target business: the owners, a couple in their 70s, were ready to retire and had no children – just 15 dogs.
Search funds started as a business school experiment four decades ago but have gained popularity in recent years as compelling newcomers armed with MBA degrees entice investors to make these niche bets with the promise of high returns. Nearly $800 million was invested in search funds in 2020 and 2021, about a third of the total amount raised for such funds since the idea was conceived, according to data from the Stanford Graduate School of Business.
“At first it was just a small group of interested students,” said H. Irving Grousbeck, an adjunct professor at Stanford. Mr. Grousbeck is credited with coming up with the idea for a search fund in 1984, when he was a lecturer at Harvard Business School and helped Jim Southern, a student in his entrepreneurial class, raise money to acquire Uniform Printing, a printer of special insurance documents. .
“Jim was an early success story,” Mr. Grousbeck said. In 1994, after a decade as CEO, Mr. Southern sold Uniform Printing for a return of 24 times its investment, according to a 2016 study on entrepreneurship by the University of Chicago Booth School of Business.
After seeding the idea at Harvard, Mr. Grousbeck went to Stanford, where he introduced the search fund model to generations of business school students. “Ultimately, the talent, capital and opportunity came together to form a true search fund community,” he said.
Today, search fund courses are taught in almost every major MBA program, including at the Kellogg School of Management at Northwestern University and the Yale School of Management, although Stanford is still one of the biggest proponents and the only institution that consistently charts data brings. the growth of the industry. Over the past ten years, the number of funds started has increased fivefold, from 20 in 2013 to 105 in 2023.
As venture capital funding has declined, tech hiring has cooled and salaries on Wall Street have stagnated, search funds have proven to be an attractive – albeit small – way to invest. The so-called average internal rate of return – the most common way for investors to estimate the potential of an investment opportunity – for all investments in search funds between 1986 and 2021 was 35 percent, well above the 15 percent that private equity funds have achieved in recent years have returned. the past two decades.
In the beginning, investors were mostly wealthy individuals backing young entrepreneurs – with hundreds of thousands of dollars to a few million – but major investors, including private equity firms, have recently started investing in search funds.
The typical search fund strategy goes like this: The entrepreneur raises an initial round of funding to cover his or her salary and travel expenses while looking for a company to buy. While there is no recipe for a successful acquisition, most share a few key ingredients: the company is profitable and in a fragmented industry (think HVAC, home health care, or waste management), and the owners are approaching retirement with no clear heir apparent.
If the future CEO finds a target, he or she will go back to the investors to try to raise a second round of financing to buy the company. Investors and entrepreneurs earn returns when the acquired company is sold or goes public for more money than it was purchased for.
Entrepreneurial MBAs from major business schools have long been able to raise millions of dollars from venture capitalists to fund their startups, and search funds have become another way for some of them to rake in big bucks straight out of college. Still, they have to convince cautious investors.
“Searchers often approach a small company from a fancy school without much experience,” says GJ King, a search fund investor.
Mr. King looks for entrepreneurs who are humble, collaborative and have a good sales pitch – three qualities he believes are essential to overcoming the skepticism of potential sellers and their employees. Only when he is convinced of these properties does he decide to invest. “People will rightly be skeptical of you,” he added.
Mr. Silva, who became CEO of MásLabor, said he wrote more than 1,000 personalized emails and made about 800 phone calls before he found the right target: a company in good financial health, with owners willing to sell .
“I looked at their finances and thought, wow, there’s something really special here,” he said of MásLabor. Mr Silva would not reveal how much he paid, other than to say it was more than twice the average purchase price of the search fund in 2021, at $16.5 million – which equates to more than $33 million.
The deal took more than five months to close and included uprooting his eight-month pregnant wife and their toddler from California and moving everyone to Virginia. (Mr. Silva closed his previous company, Henlight, after struggling to expand the business.)
As part of the deal, he also acquired AgWorks H2, a partner company of MásLabor. Mr. Silva plans to make more acquisitions to build the company.
An acquisition-based growth strategy is gaining popularity, driven in part by increasing competition among both investors and seekers. “You make a land grab, buy as many of these companies as you can and put them together,” says Peter Kelly, a search fund investor and lecturer at Stanford Business School, about the industry’s emerging M&A strategy.
Kelsey Holland, a 2023 Harvard Business School graduate who raised a search fund last year, said she was well aware of the growing competition. “There was a search,” said Ms. Holland, who had worked as a product manager at companies like Equinox before business school.
Like Mr. Silva, Ms. Holland always wanted to become CEO of a company and assumed she would achieve her goal by founding a start-up. Then, in her first year of business studies, she learned about search funds – a model she and her colleagues say they were particularly attracted to in the current economic climate.
“When you’re plugged in, you read about all these startups that you thought were doing well and are now going down, struggling and getting laid off,” she said.
In September, Ms. Holland, 33, began looking for a health care company to acquire after raising about half a million dollars from private individuals and investment firms as she looked for a company to buy. She has sent hundreds of personalized emails to business owners and met with more than twenty potential sellers.
Many of the owners she has met regularly receive emails from other searchers and private equity firms also interested in acquiring their businesses, Ms. Holland said. If she finds a company, she plans to go back to her investors and ask for an amount between $10 and $100 million, depending on the size of the target.
Ms. Holland does not think search funds are a sure path to the corner office given the increasingly competitive market, but said she was confident she would find the right company. “Nowadays we just need more creativity.”