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 we were going to find a technology start-up.”
Then a classmate told him about another path for budding entrepreneurs. Instead of starting a company from scratch — Mr. Silva had co-founded before business school and even served as CEO — he could buy one and run it. To do that, he would have to raise a “search fund,” a pool of money from investors willing to bet that an ambitious youngster with no track record would make them money.
Mr. Silva, 34, was thrilled. “I realized you don’t have to deal with VCs who have unreasonable expectations,” he said. After raising a search fund of more than $30 million from a small group of investors, Mr. Silva bought MásLabor, a Virginia consulting firm specializing in work visas, in July 2021. It was the perfect target company: The owners, a couple in their 70s, ready to retire and no kids – just 15 dogs.
Venture capital began as a business school experiment four decades ago, but has gained popularity in recent years as persuasive upstarts armed with MBAs lure investors into these niche bets with the promise of high returns. In 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 trickle of interested students,” said H. Irving Grousbeck, an assistant professor at Stanford. Mr. Grousbeck is credited with coming up with the idea for search funds in 1984 when he was a lecturer at Harvard Business School and helped Jim Southern, a student in his entrepreneurship class, raise money to acquire Uniform Printing, a printer special insurance documents. .
“Jim was an early success story,” Mr. Grausbeck said. In 1994, after 10 years as CEO, Mr. Southern sold Uniform Printing for a 24-times return on investment, according to a 2016 study of entrepreneurship by the University of Chicago Booth School of Business.
After solidifying the idea at Harvard, Mr. Grousbeck joined Stanford, where he introduced the search fund model to generations of business students. “Ultimately, talent, capital and opportunity have come together to form a true search fund community,” he said.
Today, search funds courses are taught at nearly every major MBA program, including the Kellogg School of Management at Northwestern University and the Yale School of Management, although Stanford remains one of the biggest proponents and is the only institution that consistently tracks the data mapping industry development. Over the past decade, the number of funds launched has increased fivefold, rising to 105 in 2023 from 20 in 2013.
While venture capital funding is down, tech hiring has fallen and Wall Street wages 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 venture capital investments from 1986 to 2021 was 35 percent, well above the 15 percent that has returned private equity over the past two decades.
In the early days, investors were mostly wealthy individuals who backed young entrepreneurs — giving anywhere from hundreds of thousands of dollars to a few million — but big investors, including private equity firms, have recently begun investing in search capital.
The typical search fund strategy goes like this: The entrepreneur raises a seed round of funding to cover his salary and travel expenses while he searches for a company to buy. While there’s 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 with no heir apparent. .
If the would-be CEO finds a target, he’ll go back to investors to try to raise a second round of financing to buy the company. Investors and entrepreneurs realize a return if the acquired company is sold or goes public for more than it was bought for.
Entrepreneurial MBAs from major business schools have long been able to raise millions of dollars from venture capitalists to finance their startups, and venture capital funds have become another way for some of them to raise large sums soon after graduation. However, they still need to convince wary investors.
“Searchers often approach a small business from a fancy school without a lot of experience,” said GJ King, a search fund investor.
Mr. King looks for entrepreneurs who are humble and cooperative and have good salesmanship — three qualities he believes are essential to overcoming skepticism from potential vendors and their employees. Only when he is convinced of these characteristics does he decide to invest. “People will be rightly skeptical of you,” he added.
Mr. Silva, who became MásLabor’s chief executive, said he had written more than 1,000 personalized emails and made about 800 phone calls before finding the right target – a company in good financial shape with owners willing to sell.
“I looked at their financials and thought, wow, there’s something really special here,” he said of MásLabor. Mr. Silva did not disclose how much he paid, other than to say it was more than double the 2021 search fund average purchase price of $16.5 million — which is more than $33 million.
The deal took more than five months to close and involved uprooting his eight-months-pregnant wife and their young child 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 deal, it also acquired AgWorks H2, a partner company of MásLabor. Mr Silva plans to make more acquisitions to build the business.
An acquisition-based growth strategy is gaining popularity, in part due to increasing competition among both investors and prospectors. “You do a land grab and buy as many of these companies as you can and put them together,” Peter Kelly, a venture capitalist and lecturer at Stanford’s business school, said of the industry’s emerging M&A strategy.
Kelsey Holland, a 2023 graduate of Harvard Business School who raised a search fund last year, said she was well aware of the growing competition. “The search was found,” said Ms. Holland, who had worked as a product manager at companies such as Equinox before business school.
Like Mr Silva, Ms Holland always wanted to be the CEO of a company and believed she would achieve her goal by founding a start-up. Then, in her first year of business school, she learned about venture capital — a model she said she and her peers are particularly drawn to in the current economic climate.
“If you’re plugged in, you’re reading about all these startups that you thought were doing well and now they’re booming and struggling and getting laid off,” he said.
In September, Ms. Holland, 33, began looking for a health care company to buy, having raised about half a million dollars from private individuals and investment firms as she searched for a company to buy. He has sent hundreds of personalized emails to business owners and met with over 20 potential vendors.
Many of the owners she has met frequently receive emails from other researchers and private equity firms who are also interested in acquiring their company, Ms. Holland said. If it finds a company, it plans to go back to its investors to ask for $10 million to $100 million, depending on the size of the target.
Ms. Holland doesn’t think search funds are a sure-fire path to the corner office, given the increasingly competitive market, but said she’s confident she’ll find the right company. “It just takes more creativity these days.”
