Concept Paper from Social Capital Partners
Emphasizes economics that enable diverse entrepreneurs to build equity faster, enhance business stability, and deliver fair returns to investors without requiring an exit
An increasing number of business owners are looking to retire and transition ownership. Estimates suggest over 3 million businesses across North America are owned by Baby Boomers, employing approximately 35 million people1. According to recent surveys, more than 40% of these owners plan on retiring in the next 5 years, creating a risk to employees and communities across North America. Most small businesses don’t have a succession plan, which limits their exit alternatives. Less than a quarter of business owners see succession within their family, or to key employees, as a viable exit strategy. As a result, the most attractive option is to sell the company to a third party.
Search funds are positioned to be a leading purchaser of the best small businesses. As business owners have edged closer to retirement, search funds have proliferated. Our analysis of Searchfunder.com shows that there are now over 130 search funds in North America searching for acquisitions, up 160% from 2013. We estimate that these search funds have dry power in excess of $1 billion and are one of the only buyers for small business with under 25 employees.
Search funds are an investment vehicle through which an entrepreneur raises capital to acquire a business they plan on operating. Typically, “searchers” raise capital to cover their living expenses while they pursue acquisition opportunities. Investors are high net worth individuals, while there are now some funds dedicated to supporting search funds. These investors will finance both the search and the eventual acquisition cost, and grant equity to searchers according to the return the investors receive.
We’re concerned that search funds lack diversity, industry experience and appropriate incentives. According to research from Stanford, approximately 95% of searchers are men and 80% are MBA educated. Very rarely do searchers have prior experience in the industry or the community they buy into. Moreover, the economics of the search funds promote risk-taking and almost always require the business be sold after 5-7 years. This is because investors require both a 30% annual return before searchers receive their full equity compensation and also have contractual rights to force a sale.
Social Capital Partners (“SCP”) is seeking like-minded partners to design and launch a more inclusive search fund model. We believe there are fundamental issues with the search fund model that will increase inequality and decrease economic stability. A new model for search funds would be accessible to diverse populations, and prioritize individuals who have prior experience in the industry and community they’re acquiring into. In addition, it would include economics that enable entrepreneurs to build equity faster, enhance business stability, and deliver fair returns to investors without requiring an exit. We have some ideas on how this can be done, but are looking for a lead partner to take ownership of this initiative...
