Lifting the lid on searcher comp

This week I had dinner with a few of my friends in mid-market private equity and I wondered silently how comp under the search model would compare to a mid-market PE professional. The first step: figuring out the economics of a searcher of course. Let’s dig in!

The Potential Return Profile of a Searcher Acquiring and Scaling a $2MM EBITDA Business

Search funds offer a compelling pathway for entrepreneurs to acquire, operate, and eventually exit a small to mid-sized business with significant upside potential. We’ll dig into searcher comp for a searcher who acquires a $2 million EBITDA business for 3x EBITDA ($6 million) and grows it to $6 million in EBITDA over seven years, eventually exiting at a 5x EBITDA valuation ($30 million). We will outline the financial implications for both the searcher and investors while highlighting key benefits of this approach.

Deal Structure and Financial Overview

• Acquisition Price: $6 million (3x EBITDA of $2MM)

• Equity Contribution: $3 million (fully funded by search investors, who receive a 2x step-up on their initial investment)

• Debt Financing: $3 million at 10% interest

• Searcher’s Compensation: $150,000 per year in salary

• Searcher’s Equity Participation: 20% of the equity value created

• Exit Valuation: $30 million (5x EBITDA at Year 7)

Debt Repayment and Cash Flow Considerations

The debt component of $3 million is financed at a 10% interest rate, meaning the business incurs an annual interest cost of $300,000. Assuming the business generates sufficient operating cash flow to cover this debt service, it is reasonable to assume that the debt will be fully repaid within the seven-year period, allowing the equity value to appreciate unencumbered.

“Back of envelope” Equity Growth and Investor Returns

At exit, the business is sold for $30 million. The initial investors had committed $3 million and were entitled to a 2x step-up, meaning they receive $6 million first. The remaining $24 million of equity value is what constitutes the “equity value created,” of which the searcher retains 20%.

• Total Exit Value: $30 million

• Investor Return: $6 million (2x their original $3MM investment)

• Equity Value Created: $24 million ($30 million - $6 million investor payout)

• Searcher’s Equity Stake: 20% of $24 million = $4.8 million

• Total Compensation to Searcher:

  • Salary Over 7 Years: $150,000 × 7 = $1.05 million

  • Equity Payout at Exit: $4.8 million

  • Total Economic Benefit: $5.85 million

  • Annual Economic Benefit: ~$835,000

IRR Calculation for Investors

The investors contributed $3 million at the start and received $6 million (2x step-up) plus the remaining equity value of $19.2 million ($24 million equity value created minus the searcher’s $4.8 million cut), bringing their total payout to $25.2 million. The IRR (internal rate of return) for investors over a 7-year period can be calculated using the formula for compound annual growth:

This IRR significantly outperforms traditional private equity benchmarks, making the investment highly attractive.

Key Benefits to the Searcher

1. Autonomy and Control Over a Scalable Business

   • Unlike traditional employment or even founding a startup, acquiring a small business offers the searcher immediate ownership and control over an existing operation with proven cash flows. Over seven years, the searcher has the opportunity to scale the business, optimize operations, and drive strategic growth without the existential risk that comes with a startup.

2. Significant Upside from a Relatively Small Initial Stake

   • By structuring the deal with investor capital, the searcher is able to acquire a substantial business without needing to personally contribute capital. Despite not funding the acquisition, the searcher enjoys a $4.8 million payout from the equity value created.

3. Steady Compensation and Long-Term Wealth Creation

   • With a $150,000 annual salary, the searcher is able to maintain a steady income while working toward a meaningful exit. Unlike the uncertain returns of a startup, this provides financial stability while still allowing for significant wealth creation through equity participation.

4. Mentorship and Support from Experienced Investors

   • Search investors often come with industry expertise and experience in search fund investments. This network of support can be invaluable in guiding strategic decisions, optimizing operations, and positioning the business for a successful exit.

Benefits to Search Investors

For investors, search funds provide an attractive asset class with strong risk-adjusted returns. In this case:

• The investors achieve an IRR of approximately 35.5%, far exceeding public market and even traditional private equity returns.

• They gain exposure to a hands-on, operationally driven investment that benefits from the searcher’s direct involvement in value creation.

• Given the historical IRRs of search fund investments (often exceeding 25-30%), this model remains highly compelling compared to traditional private equity investments.

Growing Role of Search Funds in Private Equity

Search funds have become an increasingly popular segment within private equity. As more entrepreneurial professionals seek alternative paths to business ownership, and as retiring business owners look for exit strategies, the demand for small-business acquisitions continues to rise.

Furthermore, the success of search funds in generating strong investor returns has attracted more institutional capital into the space. With lower competition than large-cap private equity deals and a proven track record of delivering attractive returns, the search fund model is positioned to continue expanding its footprint within the broader private equity landscape.

My take

The search fund model provides a compelling pathway for ambitious entrepreneurs to acquire, scale, and exit a profitable business while benefiting from strong financial upside, mentorship, and strategic investor support. In this scenario, the searcher walks away with $5.85 million in total earnings, while investors achieve a strong return on capital with a 35.5% IRR. Given the rising popularity of search funds and the wealth of opportunities in the small-business sector, this investment model represents a promising avenue for both searchers and investors looking to create value in the lower-middle-market private equity space.

Selected stats on search funds

The search fund model has experienced significant growth and evolution in the United States over the past few decades. According to the 2024 Search Fund Study by the Stanford Graduate School of Business, which analyzed 681 search funds formed in the U.S. and Canada since 1984, several key trends have emerged:​

• Record Number of New Funds: In 2023, a record 94 core search funds were launched, indicating a growing interest in this entrepreneurial pathway. ​

• Acquisition Activity: The number of acquisitions peaked in 2021 with 40 deals but decreased to 29 in 2023. ​

• Financial Returns: The aggregate pre-tax internal rate of return (IRR) for all search funds since 1984 stands at 35.1%, with a return on investment (ROI) of 4.5x. Notably, for companies that have exited, the IRR increased to 42.9%, up from 36.8% in the previous study, due to several significant exits in 2022-2023. ​

• Acquisition Metrics: The median purchase price of acquired companies declined to $14.4 million, representing a 7.0 multiple of EBITDA. These companies had a median EBITDA margin of 27%, a growth rate of 25%, and employed approximately 34 individuals. ​

Demographic Shifts Among Searchers

The profile of individuals pursuing search funds has also evolved:​

• Age: In 2023, 79% of searchers were aged 35 or younger, indicating a trend toward younger entrepreneurs embracing the search fund model.

• Educational Background: More entrepreneurs are forming search funds immediately after business school or without an MBA, and those with an MBA are graduating from a wider range of institutions. ​

• Gender Diversity: The participation of women in search funds has increased, with women accounting for 18% of searchers who launched in 2023.

Investor Capital and Market Dynamics

Investor interest in search funds remains robust:​

• Capital Investment: In 2022 and 2023 combined, investor capital of $682 million was invested in core search funds and acquired companies, reflecting sustained confidence in the model. ​

These trends underscore the growing appeal and evolving nature of search funds in the United States, offering valuable insights for both aspiring entrepreneurs and investors.

1  SMB Center

2  novastone-ca.com

Parting Thoughts

How you can engage with me

• I’d love to hear how your acquisition search is going—feel free to leave a comment, reply directly to this email or reach out directly at [email protected]

• If you are interested in keeping up with my search, as a potential future investor, kindly fill out this form

• If you are selling your business and would like to have a conversation, please email me

I look forward to hearing from you!