Search fund investment: a solution to family business lack of succession
One of the most common problems that family businesses have recently encountered is the lack of internal succession to ensure the continued operation of a business. This affects the overwhelming majority of small and medium-sized family businesses established in the early 90s on the wave of political change. A solution for owners who are thinking about well-deserved retirement may be the sale of business to a little-known type of fund in Poland: the search fund.
What is a search fund?
A search fund is an investment vehicle run by one or two "searchers – managers" (usually people with business experience) who have raised capital from private investors in order to seek out, acquire and run a company over the long term.
The place of birth and, at the same time, the most developed search fund market is the United States, where the creation of this type of fund was the result of a lack of succession problem. Many companies established in the United States after World War II struggled with problems similar to those faced by Polish entrepreneurs today. After successfully managing a business for about 20–30 years, owners found themselves lacking successors who would continue to develop their family businesses. The solution to these problems turned out to be an idea developed by MBA students from the Stanford Graduate School of Business who wanted to take over management from an older generation of entrepreneurs, buying out the founders with money obtained from private investors. This is what gave birth to the idea of the search fund developed by I. Grousbeck, a professor at Harvard Business School, which is supposed to provide managers with the opportunity to become owners of selected companies.
The life cycle of a typical search fund consists of four stages:
- raising a search fund (i.e., a pool of capital) from a group of matched, committed investors supporting managers to find a company to acquire;
- the search – usually lasting one to three years, during which managers identify and eventually acquire an attractive business;
- operational activities, the longest stage of the undertaking during which managers run and develop the enterprise;
- exit, at which point managers and investors obtain liquidity from their investment.
Why search funds?
The search fund has many features that make this type of fund an attractive option for founders wishing to exit a business created over years. First of all, the sale of the company to the search fund guarantees the founders the comfort that their business will be further developed and will be the apple of the eye of the new owner.
Unlike private equity funds, a search fund usually invests in a single company, and its managers personally manage it and generally move with their families to the vicinity of the company's headquarters. For them, it is the only company that they will manage and develop for several years following the conclusion of the transaction. They devote all their time to increasing the profitability and value of their first business as much as possible. It is therefore a situation similar to that prevailing in family businesses, in which founders are also the main managers.
Unlike private equity funds and industry investors, search funds do not expect professional company management and this allows the current owners to completely retire from business. Once a transaction has been completed, the managers will be responsible for running the business and will take up functions on company boards. Founders therefore no longer need to be involved in advising on day-to-day operations.
In addition, an important feature of the search fund is that its investors often actively support managers in the day-to--day management of the company. They bring a diverse set of experiences and networks, and many of them are closely involved in the acquired company, thus contributing to the professionalization of internal processes. This is different from the approach of private equity funds, where investors are usually more passive and not interested in engaging in portfolio companies.
The main objective of the search fund is the further development of the company acquired including by improving its financial results. An important role in this process is played by the family business brand identity, which has been cultivated over many years and to which the founders are particularly attached. As a rule, owners selling a business to a search fund can be sure that the current brand will be preserved and the company sold will not become part of a larger corporation. For search funds, it is also extremely important to retain employees after a transaction has been completed and to develop the business in cooperation with them. This approach is particularly appreciated in smaller family businesses that feel a responsibility towards their local communities.
An important factor when choosing a search fund as a potential external successor to a family business is also the investment period. While a typical private equity fund must return capital to investors within a certain period of time, which typically requires exiting the investment within that period, a search fund is not bound by such a time horizon. Most search funds are established in a long-term perspective. The average period of investment is typically seven years and the most profitable investments are even kept by investors for a decade or more.
Examples of investments in Poland
The search fund market in Poland is still in its infancy. Compared with other countries, such as the United States or Canada, and even Western European countries, we are at the beginning of the development of this type of activity. In Poland, three transactions carried out by search fund have been announced so far, including two this year. These investments were involving relatively young companies (with an average duration of operation of ten years).
The first transaction of this type was the acquisition in December 2020 of MotionVFX by search fund Nextline founded by Andrzej Basiukiewicz and Wojciech Korpal. The second transaction was the acquisition in January 2023 by Novastone Capital Advisors and manager Waldemar Pilch of family company ForMeds, which specializes in the production of dietary supplements. Search fund Novastone Capital Advisors was founded by a consortium of family offices and runs a special program "Entrepreneurship through acquisitions" that connects investors with so-called "prospectors" who find and invest in growing local companies on behalf of investors. The last transaction carried out by the search fund was the acquisition in June this year by Stability Capital, operated by managers Paweł Malon and Marek Jakubow, of a majority stake in Velis Real Estate Tech – a supplier of software offered under a SaaS model for servicing and managing commercial real estate.
Summary
Search funds seem to be tailored to family businesses with succession problems. They are able to meet the requirements of family business owners and thus enable entrepreneurs with succession problems to sell their business with a specific guarantee for future development. Recent investment activity in Poland indicates that such financial vehicles may start playing an increasingly important role in an era of growing family business succession problems.
Author: Paweł Jaros, Senior Associate, Baker McKenzie Krzyżowski i Wspólnicy sp.k.
This article comes from magazine:
FOCUS ON Business #12 September-October (5/2023)
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