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Young Entrepreneurs Find a Way to Make Their CEO Dreams Come True| GuyWhoKnowsThings

Edward Silva grew up wanting to be a CEO.

In 2018, Mr. Silva enrolled at the Stanford Graduate School of Business with the goal of starting his own company. “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 a technology startup.”

Then a classmate told him about another path for budding entrepreneurs. Instead of starting a company from scratch (Silva had co-founded one before business school and had even been its CEO), he could buy one and run it. To do so, he would have to create a “search fund,” a pool of money from investors willing to bet that an ambitious young man with no track record will make them money.

Silva, 34, was intrigued. “I realized that you don't need to deal with venture capitalists who have unreasonable expectations,” he said. After raising a search fund of more than $30 million from a small group of investors, Silva purchased MásLabor, a Virginia consulting firm specializing in employment visas, in July 2021. It was the perfect target company: the owners, a couple in They were in their 70s, ready to retire, and had no children: just 15 dogs.

Search funds began as a business school experiment four decades ago, but have grown in popularity in recent years as persuasive rookies armed with MBA degrees lure investors into making these niche bets with the promise of high returns. returns. Throughout 2020 and 2021, nearly $800 million was invested in search 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 few interested students,” said H. Irving Grousbeck, an associate professor at Stanford. Mr. Grousbeck is credited with the idea of ​​raising funds in 1984, when he was a professor at Harvard Business School and helped Jim Southern, a student in his entrepreneurship class, raise money to acquire Uniform Printing, a printing company. specialized insurance documents. .

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

After seeding the idea at Harvard, Grousbeck joined Stanford, where he introduced the search fund model to generations of business school students. “Over time, talent, capital and opportunities came together to form a true search fund community,” she said.

Today, courses on search funds are taught in almost all major MBA programs, including Northwestern University's Kellogg School of Management and the Yale School of Management, although Stanford remains one of the biggest proponents and is the only institution that has constantly monitored data graphs. the growth of the industry. In the last decade, the number of funds initiated has quintupled, going from 20 in 2013 to 105 in 2023.

While venture capital funding has slowed, tech hiring has cooled and salaries on Wall Street have stagnated, search funds have proven to be an attractive, if small, way to invest. The so-called average internal rate of return, the most common way for investors to measure the potential of an investment opportunity, for all investments in search funds between 1986 and 2021 was 35 percent, well above 15 percent that private equity funds have returned. the last two decades.

In the early days, investors were mostly wealthy individuals backing young entrepreneurs (donating anywhere from hundreds of thousands of dollars to a couple million), but large investors, including private equity firms, have recently begun investing in search funds.

The typical fundraising strategy is as follows: the entrepreneur raises a round of seed funding to cover his salary and travel expenses while he searches for a company to buy. While there is no recipe for a successful acquisition, most share a few key ingredients: The company is profitable and in a fragmented industry (think HVAC, home health care, or waste management), and its owners are nearing retirement. without an apparent heir.

If the aspiring CEO finds a target, he will go back to investors to try to raise a second round of financing to buy the company. Investors and entrepreneurs profit if the acquired company is sold or goes public for more than what it was purchased for.

Business MBAs at top business schools have long been able to raise millions of dollars from venture capitalists to finance their startups, and seeking funding has become another way for some of them to raise large sums immediately after graduate. Still, they have to convince cautious investors.

“Searchers often approach a small business from a fancy school without much experience,” said GJ King, a search fund investor.

King looks for entrepreneurs who are humble, collaborative and have a good sales pitch – three qualities he believes are essential to overcoming the skepticism of potential salespeople and their employees. Only when he is convinced of those attributes does he decide to invest. “People will be rightly skeptical of you,” he added.

Silva, who became CEO of MásLabor, said he had written more than 1,000 personalized emails and made around 800 phone calls before finding the right target: a company in good financial health and owners willing to sell.

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

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

As part of the agreement, it also acquired AgWorks H2, a partner company of MásLabor. Silva intends to make further acquisitions to develop the business.

An acquisition-based growth strategy is gaining popularity, driven in part by increasing competition among both investors and search engines. “You grab the turf and buy as many companies as possible and put them together,” Peter Kelly, a search fund investor and professor at Stanford business school, said of the industry's emerging M&A strategy.

Kelsey Holland, a 2023 Harvard Business School graduate who raised a search fund last year, said she was well aware of the growing competition. “The search was discovered,” said Holland, who had worked as a product manager at companies such as Equinox before studying business.

Like Silva, Holland always wanted to be CEO of a company and assumed she would achieve her goal by founding a new company. Then, in her first year of business school, she learned about search funds, a model she said especially appealed to her and her colleagues in the current economic climate.

“If you're online, you read about all these startups that you thought were doing well and now they're raising rounds, struggling, and doing layoffs,” he said.

In September, Holland, 33, began looking for a health care company to acquire, having raised about half a million dollars from individuals and investment firms while searching for a company to buy. He has sent hundreds of personalized emails to business owners and met with over 20 potential sellers.

Many of the owners he has met receive frequent emails from other seekers and private equity firms that are also interested in acquiring their company, Holland said. If he finds a company, he plans to go back to his investors to ask for between $10 million and $100 million, depending on the size of the target.

Holland doesn't believe search funds are a sure path to the front office, given the increasingly competitive market, but said he was confident he would find the right company. “Nowadays you just need more creativity.”

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