What specialist funders look for when considering Search Fund transactions

Over the last few years, Search Fund backed transactions have gained traction due to the attractive returns they can provide for investors, the alternative succession options they create for owner-managers, and the number of searchers attracted to the model of acquiring a business over starting from scratch.

Search Funds, also known as Entrepreneurship through Acquisition originated in the United States and are growing in popularity across Europe.

The traditional model sees an entrepreneur, who typically has an MBA or significant industry expertise, secure initial funding from specialist search fund investors in the form of a stipend to enable the entrepreneur to pursue the search for a suitable company and once a specific target has been identified the investors will provide more substantial funds to help finance the acquisition. The entrepreneur will typically supply some of the funding themselves, alongside the investor, with the remaining buy-out funding often provided by leveraged finance debt from a specialist lender.

Variations of the model have emerged. This includes self-funded search, which sees an entrepreneur fund their own search period, identify a company and bring in investors later. Self-funded searchers tend to offer investors less equity in the company as they have financed their own search process.

Whether it is a traditional model, or self-funded, upon acquiring the business the searcher will often take the reins, running the business alongside the remaining management team. They will run the business with a view to growing its value to be realised at a future exit, with a typical exit horizon for the searcher and investors being between three and seven years.

Search Fund targets can be broad and linked often to an existing area of expertise possessed by the searcher. However, the targets tend to be service-led businesses where growth can be accelerated through improved systems and strategy, managing costs, or through mergers and acquisitions.

The Search Fund model is an evolution on the Management buy-in (MBI) approach where a new management team comes in to acquire and run a company.

Search Fund deals are more entrepreneur-led, with the searcher often building a close relationship with the current owner, and this is a key appeal to banks like Shawbrook. 

Shawbrook can finance Search Fund transactions through cash flow lending, asset-based lending or a mixture of both.

Chris Walton, head of Shawbrook’s Corporate Leverage team explains that the former sees the bank structure its lending against the forecast cashflows of the target business, whereas with Asset Based Lending (ABL) the bank would assess its lending based upon the tangible asserts of the business, such as plant & machinery, commercial property or other company debtors or inventory.

Chris Walton, Head of Corporate Leverage, said:      

“From the cashflow perspective, we'll look at their recurring revenues and the financial performance for the last few years, how they're tracking this year vs budget and their longer term forecasts.”

“We'll be looking at the underlying profitability of the business to determine our lending appetite, which is likely to be based on a multiple of EBITDA.”

John Hunter, Director of Asset Based Lending, said:    

“Shawbrook is flexible in how it structures its approach to lending and will often create a multi-facility solution, combining cash flow lending with ABL.”

“This approach means that it can help searchers not only achieve the amount needed to complete the acquisition, but also provide working capital for the longer-term to help fund the costs of strategic initiatives that will drive growth.”

John Palmer, senior director in Shawbrook’s Corporate Leverage team, also pointed to mixed amortising and bullet debt as a method of structuring, which gives searchers added flexibility over their repayments.

An example would be structuring a £7m loan as £4m amortising straight line over 5 years and £3m in 5 year bullet debt. Amortisation sees the loan value reduced over time, with the bullet portion of the loan being interest only with the capital element paid as a lump sum at the end of the maturity period.

John Palmer, Senior Director of Corporate Leverage, said:  

"We aim to provide flexible and bespoke debt solutions that meet the needs of the business rather than a one size fits all approach.”

Shawbrook’s debt products for financing search fund vehicles starts at around £3m but can go up to £50m for asset-based lending and £25m for cash flow lending.

Chris highlights that the bank's 'sweet spot' for lending is between the £5m to £15m space, with the ability to draw experience from our deep experience in lending against both cashflows and assets, or a combination of both. 

Shawbrook say that, when deciding on whether to lend to searchers, they consider the balance of risk and whether the searcher, investor and owner are incentivised for the long-term and there is a meaningful equity contribution in place to align all counterparties.

John Palmer provided an example where a company with an EBITDA of £2m was sold for £10m, the bank would seek to fund up to £5m (50%) of that acquisition, then it would be expected that the investors and searchers contribution to be “significant”

He also added that he would also expect the vendor to defer a meaningful amount of the acquisition consideration, to ensure that they had a vested interest in ensuring a smooth handover period and continued success of the business.

John Hunter said: 

“The searcher may have had sector experience but may have never have had to deal with operations of that business and therefore the share of risk between the different parties  is really important.”

You could have an experienced and talented searcher and willing investors but if the target business does not have strong fundamentals, said John Palmer, then a bank would be unlikely to fund the search fund-led acquisition.

John Palmer said:

“A good candidate for leverage finance is a business that generates strong levels of EBITDA on a consistent basis and is able to readily convert that EBITDA into cash.”

The target business, alongside being a robust entity according to John Hunter, must have a strong Finance Director coupled with an established finance team and good governance ingrained within its DNA.

John Hunter said:

“Where we see things go wrong, there is usually a less established or effective finance function in the business.”

“This means we are not getting good information and we are not told about problems until later in the day which then reduces our scope for assisting the business and leads us into more difficult circumstances.”

If the business is strong and well run, the bank's attention will then turn to the searcher.

What qualities does a bank like Shawbrook look for in a searcher?

Experience in the sector they are going into is key, according to John Palmer, who said that it was vital that they had a clearly-defined strategy laid out before they made an approach for funding.

He also said that M&A professionals who have an understanding of core business principles and company financials are particularly well-suited.

John Palmer said:

“We look for someone who has done their homework and has some experience in the sector that they are going into.”

“They need to have a good grasp of the financials of the business and have done some due diligence themselves.”

“Soft skills such as resilience are also key.”

With a strong target and well-suited searcher in place, the bank's attention will then turn to investors and make up of the search fund acquisition vehicle.

The bank will consider if the searcher has put in their own money and if the investor profile is a good mix of institutional and family offices.

They will also examine the appetite and capability of investors to provide follow-on funding should the business require it.

John Hunter said:

“We always like to see a couple of cornerstone institutional investors in the search fund especially because they're usually more able to provide follow up investment.”

If a search fund vehicle has selected a company with robust credentials, has a prepared and able searcher and has a diversified and willing investors then it will be in a strong place with lenders when it comes to securing funding to complete the acquisition.

Find out more about funding for search fund acquisitions and see some examples of Shawbrook’s support for investors and searchers.