Ultimate Guide to Self-Funded Vs. Traditional Search

When deciding how to acquire a business, you have two main options: self-funded search or traditional search. Here's a quick breakdown:

• Self-Funded Search: You use your own money or loans (e.g., SBA loans) to fund the search and acquisition. You keep majority ownership but take on personal financial risk. Targets are smaller businesses with $500K–$3M EBITDA. Potential returns: 25–40% IRR and 3–5x equity growth over 5–7 years.

• Traditional Search: You raise funds from investors who support your search and acquisition. You receive a salary during the search but give up equity (you keep 16–30%). Targets are larger businesses with $1M–$5M EBITDA. Investors provide guidance but expect a structured exit (5–7 years).

Quick Comparison

Choose based on your financial resources, risk tolerance, and preference for independence or guidance.

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1. Self-Funded Search Model

This approach requires searchers to fully commit their own financial resources from the very beginning, covering both the search and acquisition phases without external investor backing.

Search Process
Searchers typically fund their operations out of pocket for 6-24 months while seeking deals. This often involves working with brokers and conducting direct outreach to identify opportunities.

Control and Ownership
This model offers complete control but comes with added financial pressure. Many loans used in this process require personal guarantees, putting the searcher's own assets on the line.

Risk Management
There are three main risks to consider:

• Personal assets are directly exposed.

• Lack of institutional support or guidance.

• Limited budget for the search process.

To manage these risks, searchers often rely on SBA loans, which can cover 75-90% of the acquisition cost [6]. This strategy helps conserve personal funds while retaining control over the business.

Return Expectations
Although the risks are higher, the potential returns make this model attractive. Common targets include:

• 25-40% potential IRR [1][2]

• 3-5x equity growth over 5-7 years

• 10-30% annual cash flow returns on the initial equity investment

This model stands in stark contrast to the investor-backed structure of traditional search models, offering both greater risks and potentially higher rewards.

2. Traditional Search Model

The traditional search fund model, introduced at Stanford GSB in 1984 [5], offers a structured way to acquire a business with the backing of institutional investors. While this approach lowers personal financial risk, it does come with shared control and oversight.

Financial Structure

• Initial funding of $400k-$500k raised from investors [1], followed by acquisition funding ranging from $5M to $50M [2].

Equity and Management Setup

• Searchers typically hold 20-30% equity [3].

• Investors retain 70-80% ownership [3].

• A board is established, including investor representatives and independent members.

• The searcher assumes the role of CEO, operating under board guidance.

How It Differs From Self-Funded Searches

Unlike self-funded buyers who focus on smaller businesses with EBITDA between $500k and $3M, traditional search funds target larger, more established companies with:

• EBITDA of $1M-$5M [4] and valuation multiples of 4-8x [4].

• Reliable cash flows and steady revenue streams.

• Opportunities to improve operations and efficiency.

Role of Investors

Investors in the traditional model contribute more than just capital. They offer:

• Access to exclusive deal opportunities.

• Strategic advice through board participation.

• Regular performance reviews, typically quarterly.

• A preferred return of 8-10% before profit sharing.

• Exit strategies aimed at a 5-7 year timeline.

Deal Sourcing and Execution

• Deals are sourced through a wide range of channels.

• Professional due diligence is conducted with expert input.

• Acquisition steps are thoroughly vetted by investors.

"Traditional search funds typically involve searchers targeting businesses with $10-30 million in revenue and $2-10 million in EBITDA. Their searchers usually spend 18-24 months identifying suitable acquisition targets before making a purchase." - Pacific Lake Partners, 2023

This model offers a clear and established route to acquiring a business, though it requires giving up a significant share of equity in exchange for investor funding and expertise.

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Benefits and Drawbacks

These two models differ most noticeably in three key areas: financial risk, operational control, and overall flexibility.

Financial Considerations

Self-funded searches offer the chance for greater equity but come with the need for personal financial guarantees. On the other hand, traditional searches provide a salary during the search phase but result in lower ownership stakes - usually around 16-30% [3][5]. This trade-off means less potential upside but also less personal financial exposure.

Operational Differences

The way these models operate has a direct impact on their risk profiles, making it crucial to align the choice with your comfort level regarding risk.

Control and Support Dynamics

Self-funded searches stand out for the level of control they offer. Searchers can adjust their timelines and criteria as they see fit, without needing approval. This freedom allows them to respond directly to market conditions. Meanwhile, traditional searches provide structured support from experienced investors and board members. This guidance is especially helpful for first-time CEOs during critical decisions but does come at the cost of reduced operational independence.

Deal Sourcing and Market Competition

Self-funded searchers often face less competition but work with fewer resources. Traditional models, on the other hand, benefit from extensive investor networks, which can be advantageous in more competitive markets.

Long-Term Growth and Exit Strategies

The two models also take different approaches to creating long-term value. Self-funded searches allow for greater flexibility in growth strategies and exit timelines. Traditional searches, by contrast, rely on professional networks and structured timelines, reflecting the broader trade-off between independence and institutional backing introduced earlier in the article.

Making Your Choice

When deciding between these acquisition models, think about the following key factors:

Evaluating Your Financial Position

Take a close look at your financial resources. Self-funded searches require you to use your own capital, while traditional searches involve raising funds from investors. This difference directly affects the balance of risk and reward in each model.

Matching Your Risk Appetite

Think about how much risk you're comfortable taking on. Traditional searches provide some financial security but come with the responsibility of meeting investor expectations. On the other hand, self-funded searches can offer higher potential returns but expose you to more personal financial risk.

Business Goals and Growth Plans

Referencing earlier discussions, consider the size of the business you want to acquire and your growth ambitions. The scale of your target company will play a big role in determining the most suitable model for your strategy.

Independence vs. Support

Decide how much guidance you want during the process. In a self-funded search, you have complete control over decisions but must rely on your own skills and network. Traditional searches, however, give you access to experienced investors and advisory boards, though major decisions will often require investor approval.

Career Goals and Long-Term Success

Reflect on your career aspirations and exit plans. Traditional searches can open doors to institutional networks but come with a higher risk of acquisition failure, necessitating thorough due diligence. In contrast, self-funded models allow for more flexibility in deal-making but require a strong personal commitment.

FAQs

Here are answers to some common questions, expanding on the trade-offs discussed earlier:

What is the difference between a traditional search fund and a self-funded search?

Traditional search funds rely on investor capital, which comes with structured timelines and oversight. In contrast, self-funded searches use personal resources, offering more independence in decision-making.

How do self-funded and traditional search funds compare?

The two models differ significantly in terms of financial structure and control, as shown below:

One key difference is in operational control. Traditional searchers act as CEOs but are accountable to a board, while self-funded searchers have the freedom to make strategic decisions independently. This influences both the acquisition process and how the business is run over time.