Buy a Small Business

“I Didn’t Want to Build the Next Twitter for Cats”

Search funds are the quiet, dependable, risk-averse sibling to the startup. 

Photo by Mladen Antonov/AFP/Getty Images
Not the rec room of a search fund.

Photo by Mladen Antonov/AFP/Getty Images

Silicon Valley preaches the gospel of the startup—the hard-won prestige and dazzle of turning an idea into a business and building it from scratch with a few friends (and a few million in angel investments). The story you are reading now, however, is not about Silicon Valley or startups. It’s about a different, less well-trodden road toward executive-hood called a search fund. It is decidedly not cool. But for a small number of would-be entrepreneurs who lack either the confidence or the foolhardiness to believe they can create the Next Big Thing in tech, a search fund makes a whole lot more sense.

The idea behind a search fund, in its simplest form, is this: If you want to run your own company but don’t want to start it, then why not buy one? Search funds are financial vehicles typically set up by one or two people to raise money from investors toward searching for—and eventually acquiring—a small business. In one sense, they might be loosely described as micro–private equity firms, except that unlike Bain Capital, the average search funder isn’t looking to make a quick profit off buying, gutting, and reselling a struggling business. He’s interested instead in taking a shortcut to the top of the management ladder and staying there for the long haul.

Search funds were developed in the mid-1980s and are generally credited to H. Irving Grousbeck, a professor of management at Stanford Graduate School of Business and co-owner of the Boston Celtics. Grousbeck denies that the idea was his but agrees that he helped nurture it along, starting about 30 years ago when two students at Harvard Business School asked for his advice on using several thousand dollars in funding to buy a business. “They thought it would last six months,” Grousbeck recalls. “I said, ‘You’re going to barely get started and six months will be gone.’ ”

Over the coming months and year, Grousbeck helped them through the first two stages of the classic search fund process: 1) Raise initial capital. 2) Search for an acquisition. (The remaining stages have traditionally been: 3) Manage and grow the business. 4) When the time is right, exit.) Search funds started slowly in the 1980s and then picked up steam in the ’90s and 2000s. Today, the median search fund spends 19 months looking for and acquiring a company, and raises $426,000 of initial search capital. Acquisition targets are typically businesses that have an older founder looking to retire, a middle-aged founder looking to turn over the reins, or a warring pair of co-founders that elects to bring in new management. Investor returns on search funds hover just above 30 percent and are much more reliable than those in the startup world—the successes are rarely as lucrative, but the failures are far less common.

But on the whole, search funds remain a micro-movement, with just 177 formed since 1983, of which more than 20 were raised in 2013. Within the small community of searchers and investors, there’s significant doubt that the model will ever go mainstream the way startups and Silicon Valley have.

“There are two major dings on search funds,” Grousbeck says. “The first is, ‘Well, it’s not my company.’ ” The second? “It’s not technology—most of these are services companies. It’s much more pedestrian.” The model’s biggest success story, Asurion, is a perfect example of that. Acquired in 1995 for $8 million as Road Rescue Inc. by searchers Jim Ellis and Kevin Taweel, the company has since been developed into a multi-billion-dollar corporation and the world’s largest provider of cellphone insurance. For all that Asurion can be touted as a management and search-fund coup, it’s not exactly sexy.

“There’s more romance around startups,” says Jim Edmunds, principal at investment firm Search Fund Partners. “Everyone at that age sort of thinks that they’re going to be the one that wins. With search funds, it’s a really hard slog.”

On the bright side, in exchange for that slog, searchers get one of their main advantages over startup founders: diminished risk. “Starting up a company is a double whammy in the sense that you’re coupling an inexperienced manager or managers with a business that doesn’t exist,” Grousbeck says. “So you have the inherent risk of the venture itself and layered on top of that is the risk that the people running it have never managed anything before. In the search fund model, one of those risks is eliminated.”

As might be expected, the people who pursue search funds tend to have a very different skill set than startup founders. Alex Gelman, the 29-year-old managing partner at Poplar Partners and a searcher for a little more than a year, says he knows he’s better at scaling a business than starting something from scratch. He’s also quite conscious of search funds’ unglamorous reputation. “After graduating from Stanford, you could be running a sexy tech company in San Francisco,” he says. “Search funds don’t buy sexy tech companies in San Francisco. I can’t tell you how many people have said to me, ‘I’d love to partner with you, Alex, but I’m not ready to go tell my significant other that we’re moving to Atlanta to go run a security business.’ ”*

The willingness of search funders to embrace the dull, the unremarkable—the businesses unlikely ever to find the spotlight—is what truly sets them apart from those flocking to tech startups; the distinction is emblematic of a rift between Silicon Valley and the larger entrepreneurial community. Though applications to business school remain strong, the Valley, with its ping-pong-playing coworkers and hoodie-adorned CEOs, has lately turned up its nose at MBAs and “traditional” management education. Students who come out of standard business programs, the thinking goes, are not trained to be adaptive leaders of the so-called “digital” economy. At the same time, the output of that economy has started to become a parody of itself, with legions of twentysomethings devoted to solving “increasingly minor First World problems,” as New York magazine’s Jessica Pressler put it in a May piece on the startup Washio’s goals to “disrupt”… laundry.

Search funds are small and might remain small. They will never be as alluring as startups. But in a way, search funds are also tech’s natural complement. “I wasn’t excited about going and building the next Twitter for cats,” Gelman says. “A search fund might not have the glamour of Silicon Valley, but at the end of the day, if I’m successful, after we close, I get to stand up in front of a group of 40 people and say, ‘Hi, I’m the new CEO.’ At an incredibly young age. Of a real company.”

Correction, Oct. 1, 2014: This article originially misquoted Alex Gelman as discussing a hypothetical “securities business” in Atlanta. He was discussing a security business. (Return.)