Mukul Pandya is an associate fellow at the Said Business School of the University of Oxford. He is the retired founding editor in chief of Knowledge@Wharton, the online management journal of the Wharton School of the University of Pennsylvania.
At a time dominated by tech startups and unicorn valuations, a quieter revolution is reshaping entrepreneurship. A growing cohort of ambitious professionals is shunning both the corporate ladder and the high-risk world of startups for a more measured approach: acquiring and running existing small and medium-sized enterprises (SMEs). Two prominent models in this space are search funds and Management Buy-Ins (MBIs), each offering unique advantages and challenges for aspiring entrepreneurs.
For the past few decades, the search fund model has been a path to entrepreneurship through acquisition or ETA. Pioneered at Stanford Business School in the 1980s, search funds involve entrepreneurs raising capital to support a dedicated period of searching for and acquiring a suitable target company. This model has gained significant traction, particularly in North America and increasingly in international markets.
The 2022 study on international search funds by IESE Business School reveals a record 44 new funds launched in 2021, accompanied by 23 new acquisitions. While most activity has been concentrated in Europe and Latin America, searches are beginning to emerge in Africa and Asia, signalling the model's global potential.
The financial performance of search funds varies widely. According to the IESE study, “As an asset class, international search funds achieved an ROI of 1.9x and an IRR of 19.4%. The median search fund returned 1.1x of initial search fund investors’ capital, whereas the top-performing search fund returned 21.7x. When unsuccessful searches were excluded, returns increased slightly. These returns are lower than in the last IESE study, decreasing from 2.4x in 2020 to 1.9x in 2022.”
A study from the Stanford Graduate School of Business, however, shows higher returns than those mentioned in the IESE study. The Stanford research notes: "Returns from all search investments since 1986 increased slightly in the 2022 study compared to the 2020 study, with aggregate pre-tax returns of 35.3% internal rate of return (IRR) and 5.2x return on investment (ROI)2. In the past two years, four new companies achieved ROIs in excess of 10x, raising the total number of search funds with greater than 10x return to 17.” (“2022 Search Fund Study: Selected Observations" by James McDonald and David Dodson, Stanford Graduate School of Business.) The Stanford study focuses on search funds primarily in North America, which may account for some of the difference. In addition, the Stanford study has a longer track record and includes more mature investments, which could contribute to the higher returns.
The surge in ETA's popularity is driven by several converging factors. Chief among these is the looming succession crisis in the SME sector. As baby boomer entrepreneurs approach retirement age, many lack clear successors within their families or organizations. Without viable alternatives, these business owners may be forced to liquidate their firms, potentially leading to widespread job losses and economic disruption.
The European Commission estimates that “Every year approximately 450,000 firms with 2 million employees are transferred to new owners across Europe, leading to the loss of an estimated 150,000 companies with 600,000 jobs.” An IFC report states that in Switzerland alone, “every year, some 16,000 companies are faced with a succession [challenge]. It is estimated that 3,400 of them may have financial problems due to the lack of specific succession rules for companies.” ETA offers a solution to this looming challenge, providing a lifeline for retiring entrepreneurs and their employees.
Simultaneously, it offers ambitious young professionals a faster route to the C-suite than traditional corporate ladders. By connecting ageing entrepreneurs with young, ambitious leaders, these models ensure the continuity of vital businesses and preserve jobs. Richard S. Ruback and Royce Yudkoff note in their book, HBR Guide to Buying a Small Business, that purchasing a small company offers significant financial rewards--as well as personal and professional fulfilment. Leading a firm means entrepreneurs can be their own boss, put their executive skills to work, fashion a company environment that meets their own needs, and profit directly from their success.
As Walker Deibel, author of Buy Then Build, notes, "The main benefit of acquisition entrepreneurship is that existing companies are already established with customers, brand awareness, employees, and most importantly, revenue and profits.”
The search fund model offers several compelling advantages for aspiring entrepreneurs. It provides a structured approach, offering a clear framework for identifying and acquiring businesses. This structure is complemented by robust investor support, with searchers benefiting from both the financial backing and strategic guidance of experienced investors. The potential for high returns is a significant draw; successful search funds have demonstrated the ability to generate substantial profits for both entrepreneurs and their backers. Moreover, the model catapults entrepreneurs directly into leadership roles, allowing them to step into CEO positions of established businesses without the usual years of corporate ladder-climbing.
However, the search fund approach has its limitations. The search process can be arduous and time-consuming, often stretching 18 to 24 months or longer, with no guarantee of successfully finding a suitable target. This prolonged search period can create pressure to make an acquisition, potentially leading to suboptimal choices as searchers feel compelled to justify the time and resources invested. Many searchers are recent MBA graduates with limited operational experience, which can pose challenges when taking the helm of an established business. The expectations of investors can also create tensions, as the need to generate returns may not always align with strategies for long-term business growth and sustainability.
Perhaps most critically, the stability of the search fund model can be precarious. If a few investors who had initially committed to the fund fail to follow through on their obligations, it could jeopardize the entire deal. This vulnerability introduces an element of uncertainty that persists even after a suitable acquisition target has been identified, adding a layer of complexity to an already challenging process. This potential for last-minute disruptions underscores the importance of robust investor relationships and the need for contingency planning.
Management Buy-Ins (MBIs) offer an alternative path to business ownership that may be particularly appealing to experienced managers looking to leverage their expertise. In an MBI, external managers or executives acquire a significant stake in an existing company and assume key leadership roles. This model presents several advantages that distinguish it from the search fund approach.
One of the primary benefits of MBIs is the flexibility they afford. Unlike the search fund model, MBI entrepreneurs have greater latitude in structuring deals and timelines. This flexibility extends to the types of businesses they can target. While search funds often have criteria dictated by their investors, MBIs can cast a wider net, considering a broader range of companies that might not fit the typical search fund mold. This expanded scope can be particularly advantageous for managers with niche expertise or those seeing opportunity in unconventional sectors.
Perhaps the most significant advantage of MBIs for mid-career professionals is the ability to leverage their accumulated experience. MBI entrepreneurs often bring substantial industry or functional expertise to their acquisitions, allowing them to hit the ground running and potentially add immediate value to the acquired business. This stands in contrast to many search fund entrepreneurs, who are often recent MBA graduates with limited operational experience.
Moreover, the MBI model typically involves less pressure from external investors. With access to capital from investors who make a commitment to ETA as an asset class of alternative investment, MBI entrepreneurs may have more freedom to make decisions based on long-term value creation rather than short-term returns. This can be particularly appealing for managers accustomed to balancing multiple stakeholder interests and focused on sustainable growth strategies.
When comparing MBIs to search funds, several key differences emerge that are worth considering for any manager contemplating this path to entrepreneurship. The funding structure, for instance, tends to be more flexible in MBIs. While search funds typically involve a two-stage funding process—initial capital for the search phase followed by acquisition capital—MBIs can have more varied funding arrangements. This might include personal savings, private equity backing, seller financing, or a combination of these.
The process of target selection also differs significantly between the two models. Search funds often adhere to specific criteria set by their investors, which can limit their options but also provide a clear framework for decision-making. MBIs, on the other hand, can be more opportunistic, allowing entrepreneurs to pursue companies that align with their specific expertise or vision, even if they don't fit a predetermined set of criteria.
Finally, the profile of the typical entrepreneur in each model tends to differ. Search fund entrepreneurs are often younger, recent MBA graduates looking to fast-track their path to CEO. MBI entrepreneurs, on the other hand, are typically mid-career professionals with substantial industry experience, looking to apply their expertise to a business they can call their own.
For an experienced manager considering entrepreneurship through acquisition, the MBI model offers a path that allows for greater autonomy, broader opportunities, and the ability to fully leverage years of accumulated expertise. While it may require more independent legwork in terms of deal sourcing and funding, it also provides the flexibility to shape the acquisition and subsequent business strategy in a way that aligns with the entrepreneur's vision and experience.
This flexibility is evident in successful MBI cases across Europe and the United States. For instance, in Spain, Pablo Fernández-Vázquez acquired Parsemus Group through an MBI in 2012. Leveraging his industry expertise, he grew the company from 15 to more than 200 employees, expanding its services and geographical reach before successfully selling to a larger IT services firm in 2019. This case, highlighted in the IESE Business School study, demonstrates how MBI entrepreneurs can apply their sector-specific knowledge to drive significant growth.
In the United States, the acquisition of Cloverleaf Cold Storage by Bill Feiges and Daniel Kaplan in 1996 offers another compelling example. Over two decades, they transformed a small, regional player into the fifth-largest cold storage company in North America, eventually selling to Americold Realty Trust in 2019 for $1.24 billion. This case, also mentioned in the IESE study, illustrates how MBI entrepreneurs can leverage their experience to identify opportunities in traditional industries and execute long-term growth strategies.
From the perspective of investors, both search funds and Management Buy-Ins (MBIs) offer compelling opportunities, each with their own distinct risk-return profile. Search funds present a structured investment process, which can be appealing to some investors. However, this upside comes with increased risk, primarily due to the typically less experienced operators at the helm of these acquisitions.
MBIs, on the other hand, provide investors with a more diverse array of investment opportunities. The experienced operators often involved in MBIs can potentially deliver more steady and predictable returns. This operator experience also tends to lower the overall risk profile of MBI investments. This offers investors the opportunity to tap into the entrepreneurial spirit and potentially high growth of small and medium-sized enterprises, while still benefiting from the relative stability of established businesses with existing cash flows.
As we look to the future, acquisition entrepreneurship may well play a crucial role in addressing the succession challenges faced by ageing entrepreneurs, providing opportunities for a new generation of business leaders, and offering larger investors access to a diverse and potentially lucrative asset class. By aligning all interests, it could help ensure the continued vitality of the SME sector that forms the backbone of so many economies around the world.
