enabling entrepreneurs - ey.com · for entrepreneurs who want to build and manage their own ... at...

Enabling entrepreneurs The evolution of search funds in Canada

2 | Enabling entrepreneurs The evolution of search funds in Canada

There’s been an evolution in the buyer universe on the lower end of the middle-market. Today there are more individuals and groups seeking to buy businesses that are below the radar of many traditional PE buyers.

Search funds are an investment vehicle in which investors provide capital to an entrepreneur while they seek to identify and acquire a private company. A search fund offers benefits to both eager young entrepreneurs and investors looking for growth opportunities. Search funds have become an increasingly popular investment vehicle in Canada.

For entrepreneurs who want to build and manage their own business — but don’t have the means or the “eureka” moment to start a business from scratch — search funds offer the opportunity to find a privately held business that they can acquire and operate.

At the same time, search funds can provide a great opportunity for investors to diversify their portfolio and invest in businesses that can grow and yield a high return when they’re ultimately sold.

How it worksA search fund starts with investors who make capital available to a searcher (or two) who’s looking to buy a privately owned company. A second round of funding is required to provide the equity to acquire the company. In that round, the original investors have the option to participate or not.

Following the acquisition, the entrepreneurs operate the business with a board of directors that includes a small number of the investors.

We’ve worked with many of Canada’s most successful search fund entrepreneurs and investors, and we’ve identified several unique factors both should consider.

Enabling entrepreneurs The evolution of search funds in Canada | 1

Considerations for searchers

Establish credibility You may be drawn to search funds for a variety of reasons. The challenge of running and growing an existing private company and the potential and financial rewards are typically the main attractions.

But one of the most significant challenges you could face early on is establishing credibility with your potential investors to obtain funding for the search. While there’s no specific path to earn this credibility, there are some options you may wish to try.

Securing an introduction with a potential investor through someone you trust can help lay a solid foundation for credibility. Investors are looking for entrepreneurs who they believe can find deals, use good judgment in selecting a deal and successfully manage the business. All of that involves a unique blend of intelligence, people and analytical skills, and can be a different management experience.

More investors are now familiar with the concept of search funds. Searchers now have more options outside of the traditional US search fund investors. However, US investors tend to execute initial fundraising in a more efficient fashion due to thier familiarity with the model and the fact that many invest in multiple search funds.

An additional challenge you may need to overcome is meeting with target company owners who may be skeptical or unaware of search funds. While a business sale to a search

fund presents a unique opportunity to company owners compared to a strategic or private equity sale, business owners may be uncertain as to how a young and relatively inexperienced entrepreneur could secure the financial backing and have the competence to take over the company and lead it successfully.

With an increasing number of search funds in the market, more companies are being contacted by searchers. A company’s experience with previous searchers can influence their perception of the searcher. As more searchers canvas the market, it can become more difficult to differentiate yourself. You need to be different and stand out from the rest of the pack. You need to be able to convince a potential seller to work with you and to demonstrate your suitability and drive to take over the business and continue to manage it successfully into the future.

Flexibility is key During the initial fundraising process, you’ll establish industries that are of interest to you and criteria for potential acquisitions. However, the chance of finding the business that meets all your criteria can be challenging. You’ll need to manage your expectations and look at potential businesses that may not fall into the specific categories and industries you were hoping for.

Finding the right business that meets acceptable criteria and is available for the right price will be the cornerstone to your search process — so you need to be flexible.


Account for growing pains Once you’ve identified a target and the acquisition is moving toward closing, you’ll need to set up financing to allow enough room for all the growing pains that can occur in the first year of running the newly acquired business. Operating the new business may present costs and expenses that you hadn’t initially accounted for.

Whenever you buy an existing business and look at its records, you’re looking at the past. There’s no guarantee things will stay the same after you take the reins. While completing proper due diligence is critical in understanding the company’s financial viability, there can be challenges if you want to implement cultural or process changes in an established business. Working closely with existing management is key to understanding the company’s culture and deciding the best path forward. It’s also important to be aware of the challenges involved with the search itself. The time between starting the search and the end can be a long and frustrating process. Perseverance and patience are the keys to a successful search.

Work with the right lenders and lawyers When you’re driven by the potential to own, manage and build a company, you also have a passion to own a meaningful economic stake in it. This is a fundamental difference in thinking from an entrepreneur who wants to build a business from the ground up — a difference that may be difficult for unfamiliar lenders to understand.

When you’re seeking funding, it’s important to work with a lender who’s familiar with the search fund model. Canadian lenders are becoming more omfortable with cash flow at the lower dind deals of the middle market. It’s equally important to work with lawyers experienced in search funds. Someone who’s already versed on the process will have an understanding of what’s required and the structures of typical transactions.

Considerations for searchers (cont’d)


Considerations for investors

Weigh the risks with the potential rewards Search funds can provide a great opportunity for you to diversify your portfolio mix and invest in businesses that can grow and yield a high return when they’re ultimately sold. However, as with any investment strategy, there are also attendant risks. There is no guarantee an aspiring entrepreneur will locate and secure a business to acquire in the timeframe that is financed by the initial investment round.

If you’re only looking to work with one principal, you must be comfortable taking on the risk that the searcher may not find a target business. Investing in more than one entrepreneur yields higher chances of success in finding the right business, but it requires more capital and risk on your part. You should weigh your options and understand your investment limits carefully before undertaking the search fund process. You must have faith in the people you’re choosing to invest in.

Guiding the searcherBeyond providing the capital to fund the search process and acquisition, you may be able to act as a high-quality advisor in the business relationship. Investors can provide valuable guidance through the initial search for a business by introducing entrepreneurs to key contacts and networks. You may have key contacts in the banking and legal sectors and can help introduce entrepreneurs to the right people in their targeted industries.

After the business has been acquired, you can also serve as a knowledgeable resource to the searcher as a key stakeholder in the business or by sitting on the company’s board of directors. Ultimately, it will be up to the searcher to determine your level of involvement in running the business, since not all investors can have a seat at the table.

You need to be comfortable with the notion that you won’t have the full say in the business and you’ll nee to have confidence in the entrepreneur and the board to do what’s best for the business.


Be flexibleWhen an entrepreneur ultimately finds the right business fit, it may not fit the business model you’re looking for in an investment. So you should be as flexible as possible, as you’ll need to be open to different potential types of businesses to invest in, or risk diluting your share of the fund by not investing additional capital in the acquisition.

The typical acquisition target for all search funds will have similar criteria, such as growing and recurring revenues, a minimum threshold for EBITDA margins, low technological risk and low inventory and capital expenditure requirements. However, keeping a broad list of other criteria such as industry focus will increase the likelihood of a potential acquisition business meeting your investment criteria.

Searchers will often look for one or two “lead investors” who strongly support a proposed investment. The lead investor may put more money into the deal, help rally support, or may have a board role after closing.

Is a search fund right for you?The search fund process can be a challenging yet rewarding experience. For entrepreneurs, it represents a good vehicle for investing in small private businesses (often smaller than typical private equity targets). The process provides a great opportunity to gain business experience and build a high-calibre network of associates, and presents the opportunity to run and grow a successful business and profit on the eventual sale.

For investors, search funds can provide an excellent alternative for portfolio diversification and are a great option for high-net-worth individuals who are looking to invest in the private business sector outside of typical private equity channels.

While search funds are still a relatively new investment vehicle in the Canadian business landscape, judging by the number of successful acquisitions and new search funds being formed, they appear to be here to stay.

Considerations for investors (cont’d)


We can helpWhether you’re an ambitious entrepreneur looking to acquire a business or an investor eager to introduce a new element to your portfolio, we can guide you along your journey. We can introduce you to the right contacts in the industry and help you execute from inception to the end of a search fund.

Contact one of our business advisors today at [email protected].

EY | Assurance | Tax | Transactions | Advisory

About EYEY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities.

EY refers to the global organization and may refer to one or more of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients.

For more information about our organization, please visit ey.com/ca.

© 2017 Ernst & Young LLP. All Rights Reserved. A member firm of Ernst & Young Global Limited.

2483912 ED 00This publication contains information in summary form, current as of the date of publication, and is intended for general guidance only. It should not be regarded as comprehensive or a substitute for professional advice. Before taking any particular course of action, contact Ernst & Young or another professional advisor to discuss these matters in the context of your particular circumstances. We accept no responsibility for any loss or damage occasioned by your reliance on information contained in this publication.

ey.com/ca

enabling entrepreneurs - ey.com · for entrepreneurs who want to build and manage their own ... at...

Documents