If you’re involved in deal-making professionally, chances are you’ve encountered search funds and fundless sponsors frequently this year. Although they were virtually unknown (or incognito) just a few years ago, fundless models seem to be cropping up in deal competition everywhere. Multiple factors have contributed to their popularity and competitive position in lower middle market acquisitions.
The Search Fund Versus the Fundless Sponsor
Unlike traditional private equity firms — where general partners raise funds from investors — fundless models operate with no committed capital with which to invest as equity in an acquisition. Since emerging in the early ’80s, two basic fundless models have developed: the search fund and the fundless sponsor.
The model of modern search funds is broken down in a 2013 Stanford Graduate School of Business study, which collected data from 177 search funds. A search fund involves one or two principals targeting two to four industries for approximately two years with the intent to purchase one business and run its day-to-day operations post-transaction.
A search fund gets its name because principals raise $300,000 to $500,000 to fund the search. Once a target acquisition has been identified and is under a letter of intent, the principal(s) will go to search-stage investors and other sources to raise the equity needed to close the transaction.
In contrast, fundless sponsors operate more like traditional private equity firms. They consist of a professional management team that does not intend to take over direct day-to-day operations of an acquisition target.
Rather, fundless sponsors are usually adding to an existing portfolio. They may have previously raised a fund — the holdings of which may still be a part of the firm’s operating portfolio. Fundless sponsors are generally experienced financial acquirers with known performance metrics on past investments and extensive capital-oriented networks.
Written by Brent Beshore for Forbes