Business

Young entrepreneurs find a way to make their CEO dreams come true

Edward Silva grew up wanting to be a general manager.

In 2018, Mr. Silva enrolled at the Stanford Graduate School of Business with the goal of starting his own business. “I was going to live the Stanford dream,” he said. “I was going to find an engineer – we were going to find a venture capital firm and found a tech start-up.”

Then a classmate told him about another path for budding entrepreneurs. Instead of starting a company from scratch — Mr. Silva had co-founded one before business school and had even been its chief executive — he could buy one and run it. To do this, he would have to raise a “search fund”, a reserve of money from investors willing to bet that an ambitious and inexperienced young person will bring them money.

Mr. Silva, 34, was intrigued. “I realized there was no need to deal with venture capitalists who have unreasonable expectations,” he said. After raising a research fund of more than $30 million from a small group of investors, Mr. Silva acquired MásLabor, a Virginia consulting firm specializing in work visas, in July 2021. was the ideal target business: the owners, a couple in their 70s, were ready to retire and had no children – just 15 dogs.

Search funds began as a business school experiment four decades ago but have gained popularity in recent years as persuasive newbies armed with MBA degrees lure investors into making these niche bets with the promise high yields. In 2020 and 2021, nearly $800 million was invested in research funds, about a third of the total amount raised for such funds since the idea emerged, according to data from the Stanford Graduate School of Business .

“At first it was just a handful of interested students,” said H. Irving Grousbeck, an assistant professor at Stanford. Mr. Grousbeck is credited with coming up with the idea for the research fund in 1984, when he was a lecturer at Harvard Business School and helped Jim Southern, a student in his entrepreneurship class, collect funds to acquire Uniform Printing, a specialty insurance document printer. .

“Jim was one of the first to succeed,” Mr. Grousbeck said. In 1994, after 10 years as chief executive, Mr. Southern sold Uniform Printing for a 24-fold return on investment, according to a 2016 study on entrepreneurship by the University of Chicago Booth School of Business.

After pitching the idea at Harvard, Mr. Grousbeck moved to Stanford, where he introduced the search fund model to generations of business school students. “Eventually, talent, capital and opportunity came together to form a true community of research funds,” he said.

Today, research funds courses are taught at almost every major MBA program, including the Kellogg School of Management at Northwestern University and the Yale School of Management, although Stanford remains the one of the biggest proponents and be the only institution to consistently track data mapping. the growth of the industry. Over the past decade, the number of funds launched has quintupled, from 20 in 2013 to 105 in 2023.

As venture capital funding declines, tech hiring has slowed, and salaries on Wall Street have stagnated, research funds have proven to be an attractive, albeit modest. The so-called average internal rate of return – the most common way for investors to assess the potential of an investment opportunity – for all search fund investments between 1986 and 2021 was 35 percent , well above the 15 percent that private equity funds reported. the last two decades.

At first, investors were mostly high-net-worth individuals who backed young entrepreneurs – donating anywhere from hundreds of thousands of dollars to a few million – but larger investors, including private equity firms, have recently started investing in research funds.

The typical search fund strategy is: the entrepreneur raises an initial round of financing to cover salary and travel expenses while looking for a business to buy. While there is no recipe for a successful acquisition, most share a few key ingredients: the company is profitable and operates in a fragmented industry (think HVAC, home health care, or asset management). waste), and its owners are approaching retirement with no apparent heir.

If the future CEO finds a target, he will turn to investors to try to raise a second round of financing to buy the company. Investors and entrepreneurs realize a return on their investment if the acquired company is sold or goes public at a price higher than when it was purchased.

Entrepreneurship MBAs at top business schools have long been able to raise millions of dollars from venture capitalists to finance their start-ups, and research funds have become another avenue for some of them. them to raise large sums of money right after graduating. They still need to convince cautious investors.

“Researchers often approach a small company from a sophisticated school without much experience,” said GJ King, a search fund investor.

Mr. King looks for entrepreneurs who are humble, collaborative and have a good sales pitch – three qualities he says are key to overcoming the skepticism of potential sellers and their employees. It is only when he is convinced of these qualities that he decides to invest. “People are going to be rightly skeptical of you,” he added.

Mr. Silva, who became chief executive of MásLabor, said he wrote more than 1,000 personalized emails and made about 800 phone calls before finding the right target – a company in good financial health, with owners willing to sell.

“I looked at their financials and thought, wow, there’s something really special here,” he said of MásLabor. Mr. Silva did not disclose how much he paid, except to say it was more than twice the search fund's median purchase price for 2021, $16.5 million, which equates to more than $33 million.

The deal took more than five months to complete and involved uprooting his eight-month pregnant wife and their toddler from California and moving everyone to Virginia. (Mr. Silva closed his previous company, Henlight, after struggling to expand the business.)

As part of the deal, it also acquired AgWorks H2, a partner company of MásLabor. Mr. Silva intends to make more acquisitions to grow the business.

A growth strategy based on acquisitions is gaining popularity, in part due to increasing competition between investors and researchers. “It's a land grab, buying as many companies as you can and putting them together,” Peter Kelly, a search fund investor and Stanford business school professor, said of the emerging strategy of mergers and acquisitions. acquisitions in the sector.

Kelsey Holland, who graduated from Harvard Business School in 2023 and raised a search fund last year, said she is well aware of the growing competition. “The research was discovered,” said Ms. Holland, who had worked as a product manager at companies like Equinox before going to business school.

Like Mr. Silva, Ms. Holland always wanted to become the chief executive of a company and thought she would achieve her goal by founding a start-up. Then, during her first year of business school, she discovered research funds – a model that she and her peers said were particularly attractive to the current economic climate.

“If you're plugged in, you find all these start-ups that you thought were doing well and are now relaunching, struggling and having layoffs,” she said.

In September, Ms. Holland, 33, began looking for a health care company to acquire, after raising about half a million dollars from individuals and investment firms as she searched for a company to buy . She sent hundreds of personalized emails to business owners and met with more than 20 potential sellers.

Many of the owners she has met frequently receive emails from other researchers and private equity firms also interested in acquiring their businesses, Ms. Holland said. If she finds a company, she plans to turn to her investors to ask for between $10 million and $100 million, depending on the size of the target.

Holland doesn't think search funds are a surefire route to the corner office, given the increasingly competitive market, but she said she's confident she'll find the right company. “You just need more creativity these days.”

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