Thinking about acquiring, not starting, a business? With Entrepreneurship Through Acquisition (ETA) activity on the rise, more entrepreneurs and investors are turning to search funds as a structured route to acquire and grow businesses. Below, we outline the models, timelines and key legal steps.
What are search funds?
A search fund is an investment vehicle formed by entrepreneurs or “Searchers” to raise funds from external investors to acquire and operate an established profitable company.
Typically, Searchers look to acquire companies (in any sector) with EBITDA between £0.5m to £2.5m with potential to accelerate growth, either organically or through bolt-on acquisitions. Search funds are gaining popularity in the UK for entrepreneurs and investors alike given the recent returns (or lack thereof) in traditional asset classes such as venture capital and private equity.
Fox Williams has observed a significant uplift in Searcher or Entrepreneurship Through Acquisition (“ETA”) M&A deals in the past 18 months and the trend only appears to be accelerating.
In this article we explore the difference between traditional and self-funded search funds and generally what to expect when launching into this sector.
Traditional vs self-funded
Traditional:
Traditional search funds tend to follow the model from the 1980s whereby a Searcher established a small fund (these days around £300k – £400k) (“Initial Fund”) from traditional investors to help them in their quest to find and analyse a business to purchase. Typically the time horizon to find a business is 2 years and the investors have a generous ratchet and a first right of refusal to invest in the target business.
Once a target is identified, to fund the acquisition the Searcher will obtain additional equity from existing (and new) investors and debt from traditional lenders. In this model the Searcher will typically only be entitled to between 10% to 25% of the equity in the target upon exit.
Self-funded:
Increasingly entrepreneurs are self-funding their searches (thereby skipping the need for an Initial Fund) before bringing a network of investors together at the point of acquiring the target company.
Self-funded searchers tend to:
- Rely on raising more debt financing to complete an acquisition;
- Focus on smaller companies, often valued between £5-£15 million; and
- Aim for larger equity stakes, typically between 25% and 50%.
Self-funded search funds give searchers increased flexibility in the location, industry and size of business they target however, this approach involves greater personal risk and typically lacks some of the benefits associated with mentorship and investor support in a traditional fund.
Legal structure and timeline of search fund deals
Whether it’s a traditional search fund or a self-funded searcher, once a target company is identified, the legal process is similar:
Step 1: Agree a Letter of Intent (“LOI”). This is a non-binding indicative offer, outlining the commercial terms of the deal. It will also grant the searcher exclusivity, giving the searcher confidence to move into fulsome due diligence.
Step 2: Legal and financial due diligence: This entails engaging professional advisors to “look under the hood” of the target company to ensure the representations made by the seller in the sale process to the searcher prior to the LOI are indeed accurate and to flesh out any skeletons in the closet.
Step 3: Share Purchase Agreement: This is the main transaction document and binds all sellers and the buying entity of the searcher to purchase all the shares in the target company. This is a complex legal document and specialist M&A solicitors should be engaged.
Step 4: Funding the Acquisition: Searchers need to finalise their funding requirements with their investors (for equity) and their lender (for debt) and negotiate fulsome legal documents in relation to the same.
Step 5: Closing: Once all the legal documents are in agreed form, solicitors will arrange for signatures which will trigger funds flow from investors and the lender.
Timeline: Typically from signing the LOI to closing, we expect the process to take between 6-8 weeks (all going smoothly).
How Fox Williams can help
Fox Williams is a full-service commercial law firm with over 50 partners across all practice areas Searchers will require. In particular, we are well equipped to assist with:
- setting up traditional and self-funded search funds;
- connecting investors and searchers;
- legal due diligence;
- providing specialist M&A and fundraising (both debt and equity) support for the acquisition; and
- the eventual exit through your chosen exit route.
If you have any questions, please contact members of our Corporate team, Bryan Shaw or Olivia Brooks.
