In this paper, I explore how the accelerator model could generate adequate returns by providing a hedge against risks present in the niche private equity model known as the Search Fund.

1. Independent Study Project
Taimur Ahmad
Harvard College Class of 2021
Minimizing Risk to Achieve Optimal Outcomes for Search Fund
Entrepreneurs
Introduction:
I recently interned as a private equity analyst at the Search Fund Accelerator in Boston,
Massachusetts. My responsibilities included analyzing financial statements, business models, and
other information in the CIM (Confidential Information Memorandum) to identify potential
acquisition targets, conducting due diligence on acquisition targets by studying their business
operations, studying macroeconomic reports about the locations of these businesses, and
interfacing with brokers to source relevant opportunities. Working alongside one of the most
experienced entrepreneurs at SFA exposed me to the various protocols and norms that govern the
world of search funds. During the course of my internship, I extensively studied literature from
academic institutions around the world to gain further insights into the concept of
Entrepreneurship through Acquisition.
In this paper, I am going to argue that the traditional search fund model should be
replaced by an accelerator or incubator model that emphasizes not only funding but also
providing institutional support to search fund entrepreneurs. This support could take the form of
extensive training, mentoring, exposure to excellent industry practices, and access to important
information in the company’s database.
In order to build my thesis, I am going to first describe the economics of the traditional
search fund model, outline some of the risks and challenges that young entrepreneurs face as

2. they venture out without sufficient guidance to acquire a company, and finally explain how an
accelerator or incubator model could help deal with such challenges.
Economics of the Traditional Search Fund Model:
Note: Much of the information in the following section is taken from the Stanford GSB study
mentioned in the bibliography.
In 1984, H. Irving Grousbeck introduced the concept of a “Search Fund,” which would
allow young entrepreneurs to acquire, manage and grow an existing business. According to the
Center for Entrepreneurial Studies at Stanford Graduate School of Business, which has
conducted a series of studies on search funds since 1996, the concept has become increasingly
popular among private investors and business schools. From 1984 to 2017, $924 million of
equity capital has been invested into search funds, generating an aggregate equity value for
investors of $5.7 billion (and roughly $1.5 billion for entrepreneurs). The graph below, taken
from Stanford GSB search fund surveys, shows the growth in search funds and acquisitions:

3. The search fund process can be split into four stages:
• Raising Capital
• Search and Acquisition
• Operation
• Exit
The capital is raised in two stages: 1) search capital and 2) acquisition capital. The first stage
is used to cover administrative tasks while the search is ongoing and the second stage capital is
used to purchase the company. As explained in a study produced at the Center for Private Equity
and Entrepreneurship at Tuck School of Business at Dartmouth, investors who participate in the
first round of equity financing will buy investment units and receive “the right but not the
obligation to participate further in financing the acquisition.” Investors who do exercise that right

4. are given a stake in the acquired company that is “equal to their pro rata share of distributed
search funds plus a step-up in value.”
The search process involves a number of considerations that might depend on industry
characteristics, geography or the types of opportunistic deals (deals sourced from third parties
such as brokers) available. Generally, entrepreneurs look for industries that are growing,
fragmented and not subject to rapid change. Desirable company characteristics include healthy
profit margins, history of stable cash flows, competitive edge and a lack of customer
concentration. Of course, it is unlikely that any single option will have all the aforementioned
characteristics, so the search process naturally involves tradeoffs. Other considerations involve
size of the company, which might be dependent on the amount of financing available, potential
for future growth, middle management, basic infrastructure, and opportunities for exit. Search
fund entrepreneurs might choose to prioritize some aspects over others and so ultimately the
question of which factors arethe most important is subjective in nature. In fact, Jim Stein Sharpe,
an Entrepreneur in Residence at the Arthur Rock Center in the Entrepreneurial Management Unit
at the Harvard Business School, who has written extensively on entrepreneurship through
acquisition holds a different view, “You don’t want acquire a “great” business. You will have to
pay a premium for a great business and will have little opportunity to improve it. Instead, your
search sweet spot should be a “not- so-great” or “good” business that you can purchase at a
“great” price, and then transform into a “great” one.” The process involves evaluating limited
and more generic information about the company and industry first. If the company matches the
searcher’s standard, a Letter of Intent is submitted and a more detailed analysis of the company’s
operations and financial statements begins.

5. If the company is acquired, searchers, now acting as CEOs, have to create equity value in
the company for themselves and their investors. The study identifies three areas in which this can
be done:
• Revenue Growth in Operations, which can be carried out by enhancing sales and
marketing strategies, expanding geographically, introducing new products/services,
expanding margins through cost reductions or operating leverage, and usingadd-on
acquisitions.
• Valuation Multiple, which will involve buying at lower multiples and selling athigher
multiples.
• Financial decisions, which involve cost of capital and capital intensityreduction.
Risks Present in the Traditional Model:
The 2018 Stanford Study shows that search funds in aggregate provided an ROI of 6.9x
and an IRR of 33.7 percent. The median fund returned 1.0x of initial search fund investors’
capital, whereas the 75th percentile fund returned 2.9x and an IRR of 31 percent. However, a
small number of search funds have disproportionately increased the aggregate returns. Excluding
the top performers, the returns decrease. The pattern has been quite consistent over the years for
both Return on Investment and Internal Rate of Return. The exact figures can be seen in the
following figures taken from the same search fund survey:

6. Moreover, the returns quoted earlier are returns to investors to investors, not individual
entrepreneurs. Investors can have a portfolio of search fund investments, which helps

7. spread risk on their part, but the entrepreneurs are responsible for their particular acquisitions
and thus are at a greater risk of failure. The following figure shows that 31% of search fund
entrepreneurs were unable to acquire a business. Of the ones who were able to acquire a
business, 29% made a loss.
There are many factors that could impede the success of a search fund. First of all,
there are risks involved in searching for the right company. Searching for the right company is
an arduous process that requires a significant investment of time. The entrepreneur might fail
to identify a company-specific risk, such as customer concentration, churn, weak middle
management or poor prospects of future growth. They might miscalculate or misidentify

8. industry traits such as growth/decline trends, level of regulation, technological change or legal
and/or environmental risks. The search process can also be an emotionally challenging one
and an entrepreneur always needs to be on guard against emotionally-driven and irrational
decisions. Saying yes to a bad deal and finding oneself in a frustrating position where one
cannot grow or improve the business operations of a company could perhaps be worse than
finding no deal at all.
Even if a searcher is able to acquire a company, he/she might find it challenging to
operate and grow it since most search fund principals have little or no experience managing a
company as a CEO. They might find it hard to scale the learning curve quickly if they are
simultaneously dealing with issues as varied as inadequate infrastructure and demotivated
workforce to declining industry sales and competition from foreign market players. Most
search fund entrepreneurs have never faced such problems running an actual business and
might find themselves constrained by inexperience and a lack of institutional support. This
problem could be aggravated if a searcher decides to acquire business somewhere where they
are not fully acquainted with the local workforce culture or regulations, resulting in frictions
with other stakeholders. Although most searchers acquire companies in the same region where
the search fund is located (43% acquire in the same state, 14% in the same region while 43%
acquire in some other region according to the 2018 Stanford Study), the trend might change in
the future. With the growing popularity of search funds in Latin America and Europe,
according to a study carried out by IESE Business School in Barcelona, Spain, this challenge
might become more significant as entrepreneurs look for suitable acquisition opportunities
away from the geographical location of their funds.

9. The Accelerator Model:
The Accelerator or the Incubator Model provides institutional support to entrepreneurs
that could potentially mitigate many of the aforementioned problems. With proper
infrastructure in place, these accelerators are designed in a way that maximizes the efficiency
of the search process. Some of the following arguments are explored at length in a paper
sponsored by Dr. Steven N. Kaplan at the University of Chicago Booth School.
Searchers often have a team of analysts and interns to help develop the search pipeline.
They can help with the search process by cold-calling/emailing business owners or directly
interfacing with brokers to inquire about potential acquisition opportunities. With a well-
trained team assisting the entrepreneur, the process becomes less time and energy consuming
for the searcher.
Having the support of a well-known accelerator could also mean that the searcher does
not have to spend a lot of time developing and maintaining relationships with intermediary
bodies and can instead focus mainly on searching for the right opportunities. This might further
help alleviate some of the fears and doubts of the sellers as accelerators not only have an
established reputation but also a committed source of capital from experienced investors.
Moreover, there are opportunities for mentorship and guidance, which could prove to be
invaluable for the inexperienced and often young searchers. Most accelerator managers have
experience pursuing acquisition opportunities in the past and, as a result, have developed
significant relationships with individuals in various industries as well as with investors in
traditional private equity and/or ETA spheres. Such learning opportunities allow searchers to
avoid common pitfalls early on and quickly scale the learning curve as opposed to engaging in
trial and error experiments in a race against time and limited resources. The IESE study

10. mentioned earlier views the model as being based on a three-legged stool: the entrepreneur is the
jockey, the investor is the trainer and the company is the horse. In order to succeed in the search
race, collaboration among the trainer and the jockey is essential. After all, the incentives are
aligned in a way that for the investors to enjoy a reasonable return on their investment, the
entrepreneurs have to do well. The authors of the study describe how “there is something
symbiotic about the model that traditionally has brought together more empathetic investors with
grounded and idealistic entrepreneurs.” The different ways of analyzing acquisition opportunities
could complement one another and optimize the search process in a way that otherwise would
not be possible.
In accelerators where there is a cohort of entrepreneurs, searchers stand to benefit from
learning from one another, especially those who join the cohort later and, as a result, are much
more inexperienced. Gradually, a body of institutional knowledge builds over time, which might
not be invaluable for entrepreneurs in the first few cohorts but delivers great value to those
joining the accelerator late. The firm might have certain types of data in their database pertaining
to, for example, types of opportunities available in different industries in terms oftheir
profitability and growth, profiles of different brokers, acquisitions that have succeeded or failed
in the past and so on. Research by an individual entrepreneur, especially because they are
constricted by time, risks being not as detailed or accurate as that collected by an accelerator
with a cohort of entrepreneurs over time.
At this point, it would be appropriate to address the question of whether these benefits
can be achieved or even enhanced by either a) a self-funded model b) a model where the
entrepreneur is backed by a group of investors but not in an accelerator/incubator. So far, I have
avoided commenting on the self-funded model simply because there is very little data available

11. on it. The most extensive study carried out so far, the Stanford GSB study, omits the model in
its study. Hence, I am going to limit my evaluation of the model to purely a qualitative analysis.
While in a search-funded model, the upside might be greater since the searcher does not
have to split the equity and share the returns with the investors, the downside is greater too. In
the case of a non-acquisition or an acquisition that does not generate sufficient returns, the
searcher loses personal resources and/or those of his close friends/family members. This could
mean that he/she faces an unusually high pressure running the firm due to the risk of losing
personal assets and relationships. Moreover, there are limited or no opportunities available to
contact experienced investors and solicit their advice. As mentioned earlier, the learning curve
in the search process is steep and making the right decisions in a limited period of time without
external guidance/mentorship can be hard.
For the second model, it might be possible to contact an experienced investor base and
seek their help but that requires reaching out to investors who will not only provide the capital
but also express a willingness early on to maintain contact and give advice. Selecting the right
group of investors could be crucial here especially since investors who participate in the first
round of equity financing have the right but not the obligation to participate in further
financing. An entrepreneur who wishes to engage in additional funding for product growth or
inorganic growth through acquisition will have to be mindful of that fact.
In the accelerator/incubator model, these challenges are effectively dealt with since the
investor is backed by managers and investors with a committed pool of capital who not only
provide financing at various stages of the company but also help with legal and accounting
issues during the acquisition. They provide an environment where the entrepreneur has access to
guidance of experienced individuals as well as the institutional knowledge of the accelerator

12. body. The benefits are designed into the system. One possible criticism could be that an
entrepreneur has to give up a significant amount of equity to have access to these advantages.
While there might be some truth to that, the answer ultimately depends on an individual
searcher’s preferences and appetite for risk. I believe that an accelerator model provides a fair
tradeoff by providing protection against myriad risks in the search process.
Concluding Observations:
The search fund asset class has demonstrated impressive growth over the years with high
returns to investors. However, by solely emphasizing returns to investors who have the benefit
of diversifying their portfolio by investing in a number of search funds, we carry the risk of
ignoring or downplaying the risks that individual entrepreneurs face. As mentioned earlier in
the paper, 31% of searchers fail to acquire a company and 29% exit making either a partial or
full loss. By replacing the traditional search fund model with an accelerator or incubator one,
we can install certain systems in place that reduce the risk of searcher failure. Institutional
support for these search fund entrepreneurs would mean access to the accelerator’s extensive
database, a network of experienced managers and investors, a team of analysts and interns to
help reduce the burden of developing a search pipeline, and a cohort of fellow entrepreneurs to
learn from and impart knowledge to.
Working at the Search Fund Accelerator has allowed me to study how such a system
could be implemented practically. While searchers may still be required to invest significant
time and resources to acquire and run the right business, the institution of an accelerator
provides an important hedge against many types of risks present in the search process.

13. Bibliography
Stanford Business School – Search Fund Resources website.
<https://www.gsb.stanford.edu/faculty-research/centers-initiatives/ces/research/search-
funds/primer>
Austin Yoder & Peter Kelly (2018). Search Fund Study: Selected Observation,
Stanford Graduate School of Business.
<https://www.gsb.stanford.edu/gsb-cmis/gsb-cmis-download-auth/469696>
Josh Dennis & Erick Laseca (2016). The Evolution of Entrepreneurship Through Acquisition,
University of Chicago Booth School.
<https://polsky.uchicago.edu/wp-content/uploads/2018/03/Booth-Research-Evolution-
of- ETA_FA110716.pdf>
Rob Johnson (2014). Search Funds – What has made them work? IESE Business School,
University of Navarra
< https://media.iese.edu/research/pdfs/ST-0357-E.pdf>