Introducing the Reverse Search Fund: A Win-Win for Investors, Founders, and MBAs

Disclaimer : The following post was originally published on Axial.net.

Everything is an ecosystem. That’s one of the reasons everyone tells you to find a niche. They tell you to find a niche when you’re in college, they tell you to find a niche when you’re going to start a business, they tell you to find a niche when your business works well but could be more successful. They say find a niche in variety of ways: choose a major, corner the market, specialize—but it’s the same thing. Find a niche.

At the top of the business ecosystem dwell three countervailing forces. These forces constitute the engine that drives the business ecosystem:

  1. The owners
  2. The investors
  3. The managers

When a business runs smoothly, it’s usually because there is a happy synergy between the three countervailing forces. The owners want more profit for the business so they hire capable managers and allow them to manage. The investors want more profit for the business, so they use their skills and contacts to help the owners help the business to succeed. The managers want a higher salary, or maybe a business of their own, so they work hard to ensure the business grows.

Report back to me if you find a successful business that defies this model. I’ll tell you how much time it has before it collapses — either a buyout, or a merger, or a bankruptcy.

The Efficient Beauty of Search Funds

I don’t know who the genius is who came up with search funds, but most parties point the guilty finger at Irving Grousebeck and Stanford Business School. It’s one of those 20-20-hindsight-light-bulb moments: Why didn’t I think of that? A search fund is a brilliant way to exploit the prevailing market forces and almost go farther than guarantee success. With a properly executed search fund, one can almost “shepherd” success.

Search funds take recent MBA grads — basically the business world equivalent of an elite commando: young, force-multiplying operatives — and put them in charge of a business that is already profitable. After a successful search, the MBA uses that elite training to increase the business’ profits, market share, etc. The efficient beauty of the search fund is that the MBA is never alone. A successful search fund is like a startup without the C-suite challenge.  From the beginning the MBA has access to a wealth of commercial experience in the search fund investors, as well as the steadying guidance of a wise corporate board (without having to solicit and create one from scratch).

By 1996, regular courses on search funds were being taught at Stanford and other business schools, and now over 200 search funds have been created in the US and Canada.

The results are impressive. A 2013 study by the Stanford Centre for Entrepreneurial Studies found that the aggregate pre-tax ROI was just shy of 35% and that the aggregate pre-tax return on invested capital to be 10X.

These figures should motivate any investor, and for good reason. Having a young MBA locate an existing company that is already established, but needs expertise to “get to the next level” makes a lot of sense. Such a company has already surpassed the challenging startup years, and has, at its core, a valid business model. It just needs fresh energy, and a sharp, well trained, business mind, to accelerate growth and profitability.

Reversing the Search Fund Model

If there is a flaw in the search fund model, it is that the young MBA has to basically scour the commercial galaxy for the equivalent of a Goldilocks planet. Not too hot, not too cold, not in an asteroid freeway, just the right distance from a star to allow for the perfect conditions to support life. What we’re looking for is a company that’s survived the challenging startup years, yet for one reason or another hasn’t found or exploited its niche sufficiently to catapult it into super-profitability. The search fund has to finance the search: Think travel, hotels, research, analysis, and paying the MBA a nominal salary for an undefined period of time. Companies that might be interested in both an investment infusion as well as young expertise are not that easy to find. The search itself sometimes takes a year or more. That’s a market that isn’t being served.

Enter the reverse search fund. As the name implies, a reverse search fund doesn’t start with the MBA candidate, but with the firm looking for capital and expertise. As these are harder to identify outright, starting here makes a lot of sense. Once a candidate firm has been connected to a reverse search fund, the company, or the fund itself, can contact the MBA schools to find the appropriate candidate(s) for the job.

Identifying MBA candidates in this way would be substantially less complicated than a traditional search fund model. Touching base with the most prominent MBA schools, such as Stanford, Harvard, or Wharton is fairly simple: The schools have systems in place to provide career counseling to their MBAs. (It is worth mentioning that potential high-achieving candidates can be found not only in top-tier schools but also at MBA programs across the nation, some of which might specialize in particular areas of interest to individual firms.)

An Alternative to Wall Street

After studying very hard and paying a substantial amount for business school, many MBAs naturally want to make money. Some flock to Wall Street, putting in ridiculous hours under someone else’s aegis in the hopes they will swiftly recover that substantial investment. Others prefer getting their hands dirty. Only the best — not necessarily the brightest — from either set will be uber-successful. Why don’t we augment this Darwinistic, ruthless-efficiency with humanity’s celebrated ingenuity and find a mature company in need of the commando’s expertise?

In this scenario, there are several considerations that support the reverse search fund model.

  1. As baby boomers begin to retire, they will need to hand the reigns of the firm to young, fresh blood. A motivated MBA can provide the perfect conduit.  There are over four million businesses that are expected to change hands in the next two decades, and most business owners don’t have a succession plan or exit strategy in place.
  2. In this model, the MBA enters the firm as CEO off the bat, and doesn’t need to spend years burning the midnight oil to advance a little.
  3. The third factor is pure economics: A regular search fund will provide the MBA with some equity, typically ranging from 15% to 25%. However, with a reverse search fund, equity can increase from 25% to just under 50%, as the target company identifies the MBA and can make a more attractive deal.
  4. Today’s digital revolution is all about the “sharing economy” and the “zero waste economy.” The unifying concept of maximizing society’s resources has spawned the likes of Uber, Air B&B, and Task Rabbit. One of the main stumbling blocks of a traditional Search Fund is that after the sale of a company, the founder of said companies are being asked to turn over their baby, and go play golf. The reverse search fund differs in that it keeps the founder engaged and utilizes his vast experience to help grow the business.

Conclusion

Right now, there is a fund for everything except the entrepreneurs. There is no founder-entrepreneur fund. If I, as the founder and owner of a million-dollar business, wanted to take my company to the next level, how can I do that at 60? I literally don’t have the energy I had at 30. The spirit is willing; the flesh though, just doesn’t respond like it used to. Also, with the passage of time has come technological advances and innovative, optimizing strategies that I’d need another four years in college just to understand.

So I need to go back to business school, while I run my business, and get younger by thirty years. Impossible.

Or.

Or, I could hire an elite business commando and get him or her, to run my campaign with not just my guidance, with veteran investor guidance as well. We know what the outcome of such campaigns are already. 10X. I could use 10X. Couldn’t you?

About Jeff Meltzer

Jeff Meltzer

Jeff Meltzer is an entrepreneur and founder of ReverseSearchFund.com, which helps small business owners connect with search fund opportunities. With over twenty years of running a successful business in Southern California, Jeff recently decided to start ReverseSearchFund.com as an educational resource for fellow entrepreneurs who may find value from a “reverse” approach to search funds. Connect with Jeff on Linkedin