Crowdfunding can be used to raise capital for a wide range of ventures. From non-profit and charity organizations to for-profit, entrepreneurial businesses. Crowdfunding campaigns have been started for businesses operating in numerous industries, including technology, consumer goods, real estate, and many more. Given the versatile nature of crowdfunding, you may be wondering if it is a viable mechanism to raise capital for your search fund. Below we review what a search fund is and if crowdfunding might be useful when raising funds.
Search funds have been gaining in popularity with a select group of investors and entrepreneurs over the past few years. At a basic level, a search fund is an investment vehicle in which the capital of investors is pooled to fund an entrepreneur who will search for, acquire, scale, and eventually sell an existing business. This fund model was designed to allow talented individuals the opportunity to own a business while having lower downside risk that comes with starting from scratch.
The traditional search fund is broken up into four stages:
1. Raising Capital
Prior to starting the search, the entrepreneur(s) will raise an initial amount of capital from investors that will be used for a salary and administrative expenses. This stage usually takes 6 months or less. The searchers raise funds from a group of investors using a private placement memorandum (PPM).
2. The Search & Acquisition
Armed with search capital the entrepreneur begins the search for a viable acquisition target. This process can take up to 2 years while the entrepreneur finds and acquires an existing business that has good margins and owners that are willing to sell.
Once a viable target has been identified, due diligence has been conducted, and terms have been negotiated the entrepreneur will raise their second round of capital. The acquisition capital may come from the initial group of investors, or the entrepreneur may be required to find additional sources.
It should be noted that in the event the entrepreneur fails to find an acquisition target before running out of the initial capital the search fund is dissolved and the investors do not receive a return.
Positioned as the CEO of the newly acquired company, the entrepreneur is now responsible for creating value. This may come from add-on acquisitions, revenue growth, improving margins, or expanding the company (product line, geography, etc.).
The final task for the entrepreneur after scaling the company is to find a buyer that will pay an amount enough to provide a good return to the investors and entrepreneur. When it is all said and done, the search fund is normally operated for 5-7 years.
As was mentioned in the first paragraph, crowdfunding has been and can be used for a wide variety of projects. It stands to reason that it could be used for entrepreneurs looking to raise a search fund. A variety of platforms exist that facilitate equity crowdfunding campaigns and where entrepreneurs could go to find capital. Before getting your PPM in place and signing up with multiple platforms, it is necessary to weigh the pros and cons of crowdfunding your search fund.
1. Equity crowdfunding sites receive a high amount of investor traffic. In addition, many sites already pre-screen investors to ensure that they are accredited. The pre-screening gives the entrepreneur confidence that the people they are speaking with are able to invest should they decide to.
2. Using a platform could reduce the time it takes to raise funds. An entrepreneur with a strong background, good terms, and a solid pitch could be funded quickly, getting them to the search phase sooner. Additionally, entrepreneurs could quickly access additional investors on the platform if they require more funds for the acquisition phase.
1. The entrepreneur may not know each investor personally. Some crowdfunding platforms operate where a syndicate sponsor represents all the crowdfunded shares. This could reduce the entrepreneur’s opportunity to turn to the investors for advice, if needed.
2. Platform fees. The entrepreneur will most likely enlist the help of an attorney to draft the PPM but using a platform could incur significant fees. Those individuals with a strong personal network of accredited investors may opt to go directly to people as opposed to paying the platform a percentage of the raise.
Search funds are relatively new and are gaining in popularity. As more young and motivated individuals seek to own their own business, we may just see them turn to search funds. Only time will tell if equity crowdfunding platforms will play a critical role in the fundraising phase.