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The Business Magazine July 2024
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Search Funds: could this be what you’re looking for? 

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Business succession planning is an age-old concern. Owners want to ensure that whatever the future of the business, it benefits the company – and the employees. They may want to let go of the reins but continue contributing to the success of the business, writes Oliver Wilson, Managing Director, Commercial Loans at Shawbrook. 

Luckily, there are many entrepreneurs with the skills and desire to own, run and grow a business, and prefer to buy an already successful SME rather than risking starting a business from scratch. 

A little-known but growing trend has taken hold in the UK that helps connect entrepreneurs with smaller SMEs exploring their succession plans. Entrepreneurship Through Acquisition, which originated from Stanford Business School in the US in the early 1980s, enables individuals to acquire an established business where the owner is thinking about moving on and may not want to consider selling to trade or private equity due to a desire to protect and reward the teams who helped them on the journey. 

What is an Entrepreneurship Through Acquisition and how does it work? 

By the time they have reached mid-career, many professionals – such as MBA students and aspiring entrepreneurs who want to own their own business, will have accumulated the right skills and experience to operate and grow it. The Entrepreneurship Through Acquisition model provides a defined route for those individuals to acquire a single, established SME and operate it, typically as its MD/CEO with a view to gaining an equity position. This represents a lower risk proposition than starting a business from scratch, and can provide vendors with an alternative exit option to selling to trade or private equity. 

Either way, they will need capital. Those deciding on Entrepreneurship Through Acquisition will often make a personal contribution alongside raising equity from investors which can often be found in their MBA alumni networks and circles. 

Investors will typically commit smaller amounts (perhaps around five per cent of the total), providing a platform from which the entrepreneur can work and often provide a stipend or income for the entrepreneur so they can search for the right opportunity. 

The entrepreneur will then often engage with a lender such as Shawbrook to add a debt element to the funding package to secure the eventual acquisition. The equity raised alongside the debt funding from a lender enables the ‘searcher’ to find and approach businesses that meet their criteria. The costs associated with the search will include market research, travel, networking, due diligence, legal and advisory fees.  

The searcher aims to build a relationship with the target business owners once they have been identified. Some may not have heard of, let alone considered this exit strategy before, or in some instances had not considered exiting at all. 

Lots of factors must converge for a transaction to happen, and the search period can often extend to months or even years before a perfect match is found and even then, time is needed for the deal to be agreed. 

How can specialist lenders help? 

While the equity raised from investors (and their own personal contribution) will support the searcher in their quest to find a business, the searcher will often require additional support to make the acquisition, which is where a specialist lender will come in. 

Specialist lenders like Shawbrook have the expertise to support the searcher by helping to identify the fundamentals needed to secure debt. This allows the entrepreneur to build this into their search and deal structuring strategy and reduces potential risk later on. 

Balancing the interests of searcher, bank and vendor will increase the probability of a successful transaction. By working with a lender though the search phase, there is a better chance of ensuring a flexible funding package that enables the acquisition and any subsequent follow-on funding to support growth plans. 

It is this early engagement and understanding of the model that is the real value offered by a specialist lender. Unlike more traditional strategies such as MBOs, being brought in much earlier to the search process enables them to guide the searcher on key characteristics, giving the best chance of making a successful acquisition. 

What do we look for in a Search Fund deal? 

Shawbrook has extensive expertise in this growing market sector, and can help identify the key elements required from the searcher, target business and the deal which will make it successful and attractive to lenders. 

The searcher 

To lend to a searcher, we look for four key qualities: 

  • Meaningful previous operational experience and a level of transferrable skills in the industry (or related industry) of the company that they want to acquire. For example, we recently assisted two trained engineers in acquiring an engineering business. 
  • Leadership skills and a growth mindset to either run the company acquired as CEO or MD or to operate in a strategic capacity with the existing CEO or management team in place. 
  • Willingness to develop and be guided through the transition process. 
  • Adaptability and cultural awareness. The new owner will need to harmonise with existing employees to achieve a smooth transition. 

The business 

In addition to areas that we consider with any business we lend to, three key elements are particularly important in search transactions: 

  • Indicators of future success within the business model. Examples of this are high barriers to entry for others, value-added propositions, sticky customer bases and contractual revenues. 
  • Having an experienced financial officer or financial director in place or positioned to take over once the deal has been completed. Their clear and decisive financial management and the capability to produce robust, timely and accurate management information is fundamental to the ability to lend money. 
  • A day-to-day second tier management team that is invested, incentivised and committed to the future prosperity of the company through the deal and beyond. 

The deal 

Within the deal structure itself, we look for three key features: 

  • A balanced capital structure with a sensible mix of new cash equity (via the search investors), personal contribution from the searcher, bank debt and vendor rollover or deferred consideration. Most transactions we fund have bank debt of two to three times sustainable EBITDA supported by a minimum of 30 per cent new cash equity. 
  • Alignment of interests between the searcher, vendor and lender. Any deferred consideration due is always going to 
  • be subordinated to the bank debt and managing vendors expectations early on this point can save time and stress later. 
  • An agreed management team and strategic plan post-deal. Will the vendor still have an active role and how capable are the second-tier management team? For most deals, some vendor handover is helpful but ultimately its best for a vendor to transition out over 6-18 months. 

What do we look for post-deal? 

We want to understand the longer-term business strategy in any search deal for which we provide funding. This involves regular dialogue with the existing management team and searcher to ensure continued harmony between the new owner and existing team. Good relations within these deals are what make them so successful. 

Honest and open communication is a must, and we expect to work closely with elements like reporting, KPIs and management information, especially when there are other parties such as investors involved. 

Search Funds or Entrepreneurship Through Acquisition is still a nascent strategy within the UK but could be suitable for many aspiring entrepreneurs and businesses. The route can be long, but specialist lenders are on hand to support. 

Find out more about our funding solutions for Search Funds, click here. 

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