ETA and Search Funds: A viable M&A model?

There has been heightened interest within lower tier M&A circles about Entrepreneurship through Acquisition (ETA), particularly the use of search funds to acquire established small and medium-sized owner-operated businesses with limited succession options.

The theory is that search funds enable entrepreneurs and other professionals to raise the funds required to execute acquisitions of companies they have specifically searched for and chosen, and then install themselves as CEO.

Reports have abounded in recent months highlighting inspirational ETA success stories, discussing the history and growth of the search fund model and even detailing how search fund acquisitions are outperforming private equity and venture capital deals post-transaction.

However, these stories typically focus on the sharp end of the market. That is, deals that have gone through, often with little mention of unsuccessful entrepreneurs who have put the work into drawing up a list of targets, maybe even made progress in negotiations with owners, but can’t put the funds together for a deal.

We examine ETA and the search fund model, looking at how the process works from beginning to end, the rise of search fund M&A, as well as criticisms that have been voiced over the model and its viability both for entrepreneurs and business vendors.

ETA and search funds
Entrepreneurship through Acquisition is the process through which an individual - typically with a business background - establishes themselves as an owner by raising the funds necessary to conduct M&A and then acquiring an existing small or medium-sized business.

Entrepreneurs will usually, although not always, have extensive experience in the particular industry niche they choose to target. Many will also target ETA after coming through an MBA programme.

The rationale behind the model is that it offers a faster track to established ownership than starting a business from scratch, enabling the entrepreneur to quickly access an existing infrastructure, customer base, market share, reputation and revenue streams, with less of the risk associated with a start-up business.

Perhaps the most commonly used investment vehicles for M&A are search funds, which involve entrepreneurs raising capital in order to conduct M&A activity. The entrepreneur, or “searcher”, will formulate an acquisition plan and then seek to raise funds from a pool of investors - which can range from traditional institutions such as banks to family offices and individual investors.

Some investors are specifically involved in search fund investment and can provide entrepreneurs with advice and guidance, as well as help in identifying targets, negotiations and post-deal integration and growth.

Like private equity investors, search fund investors also aim to hold on to investments for a predetermined period of time before making an investment. Search fund hold periods, however, are typically longer than those of private equity firms - often standing at around four to six years, but sometimes lasting more than 10 years.

As with private equity investments, the aim is for the entrepreneur to grow the company to a sufficient degree that the eventual exit delivers significant returns both for them and for the original search fund investors.

A search fund is typically set up as a limited company, with the entrepreneur acting as director or founding shareholder. Investors then subscribe for equity in the firm, with the initial funds raised then dedicated to searching for the right acquisition target.

Once a suitable target has been found, the entrepreneur will, in theory, return to their investors to raise further capital in order to close the acquisition.

The ideal ETA/Search Fund pipeline
John, a professional with significant experience in the precision engineering space, decided to move on from his senior role at a well-established national firm due to a feeling that he had risen as far as he could at the company and that further upward mobility was limited.

Wishing to own and grow his own business, John considered using his expertise, experience and industry connections to start a new firm from scratch. However, the significant startup costs involved in setting up a new business, finding a space and buying or leasing equipment, combined with the UK’s stubbornly high inflation and economic uncertainty prompted him to reconsider.

Through a connection in the industry who had acquired their own business rather than starting one, John heard about entrepreneurship through acquisition and the possibility of acquiring and growing an existing business with the backing of a search fund.

After building a profile of the type of business he would like to acquire - an East Midlands-based CNC engineering company with no more than 25 employees, a longstanding customer base and EBITDA of £1 - £3 million - John began to craft a value creation plan built around organic growth post-acquisition, working with a financial advisor to craft growth projections.

John’s industry connection put him in touch with an investor who had previously backed an entrepreneur with an acquisition in an adjacent industry. Following some meetings in which John outlined his acquisition profile, growth strategy and projected returns, the investor agreed to provide funds for John to approach companies that he had already shortlisted.

John held preliminary discussions with a couple of businesses, before proceeding into more in-depth negotiations with an owner who was seeking to move on to other business opportunities. After undertaking due diligence and agreeing on a purchase price and deal structure, John exchanged documents with the owner and formally took control of the business.

Post-acquisition, John worked on enacting a smooth transition and setting his value creation plan in motion, meanwhile appointing his search fund investor as a non-executive director and advisor to the firm. Ultimately, John and his partner aim to grow the business to the point where they can exit within 5 - 7 years, delivering at least a 3.5x return on their initial investment.

The popularity of ETA and search fund deals
ETA and search funds have been growing in popularity in recent years, particularly in the US, where a Stanford Business School study from 2024 found that 90 first-time search funds were raised during 2023 - an all-time high.

Search funds are particularly popular with young budding entrepreneurs, particularly those that have recently graduated from MBA programmes. According to the Stanford Business School study, close to 80 per cent of 2023’s first-time fundraisers were aged 35 or younger.

The attractiveness of ETA and search funds to entrepreneurs is understandable, theoretically enabling them to become established business owners more quickly and with significantly less risk than if they were to start their own business.

While search funds typically target small businesses, they also tend to go for SMEs that are longstanding and well-established in their industry. This reduces the risk of the business failing post-acquisition in the event of a turbulent transition process or unseen factors such as economic shocks.

For entrepreneurs specifically, the model represents relatively low risk for what could be significant rewards. According to the FT, entrepreneurs retain at least 30 per cent equity in the search fund and are often asked to contribute very little in terms of their own capital.

Having originated in the US at Stanford University in 1984 and being deeply linked to MBA programmes (which are significantly more prevalent in the US than the UK), it is unsurprising that search funds have not been as prominent in the UK so far - but this appears to be changing.

While there is little in the way of reliable figures on search funds in the UK or on the rate at which they are being established, George Thresh of Buzzacott says that the accountancy firm has seen “the popularity of search funds increase significantly in the UK” over recent years.

The FT, meanwhile, reports that it has seen “a spike in off-market investment through search funds.” As in the US, this is strongly linked to the growing popularity of UK MBA programmes, with the likes of London Business School now offering search fund modules as part of their MBA programmes.

Another contributor to the popularity of search funds is the UK’s growing population of ageing owners at SMEs. The kind of micro and small businesses typically targeted by search funds and ETA buyers are generally too small to be targeted by buyers such as private equity firms.

For owners hoping to maximise their chances of a successful, profitable exit, search funds provide a potentially viable succession option and, crucially, one that doesn’t usually require them or their management team to remain in place post-sale.

Why investors are interested
If ETA and search funds offer potentially significant advantages to entrepreneurs and business sellers, what about the investors behind the deals? Investing into a single entrepreneur operating one privately-owned small business might seem like a high risk strategy.

In fact, for search fund acquisitions that actually go to completion, the success rate is relatively high. According to a 2022 report from Stanford Graduate School of Business, aggregate pre-tax returns on search fund investments since 1986 stood at a highly attractive 35.3 per cent internal rate of return and a 5.2x return on investment.

Looking away from a long-term perspective, a more recent analysis (using data from a 2024 Stanford Graduate School of Business report, a 2023 report from Pitchbook and data from Investopedia) suggested that search funds are not only competing with more traditional investment models, but outperforming them.

According to the analysis, search funds are averaging a net internal rate of return of 25 per cent, compared to 15 per cent for private equity investments, 12 per cent for venture capital and just 10 per cent for S&P 500 investors.

Ultimately, this is maybe unsurprising, given the fact that these are often relatively small investments, backing entrepreneurs with industry experience to lead companies that are, typically, already profitable when they are acquired.

Of course, in some scenarios, the entrepreneurs involved will be less experienced (a natural consequence of the fact that so many are graduates fresh out of MBA programmes) - underlining the importance of securing supportive investors and the right guidance.

In May 2024, Aurias, a search fund founded by Daniel Cardenas-Clark and Amir Nooriala, completed the acquisition of cybersecurity services provider Saepio Information Security.

Prior to making the acquisition, Aurias had reviewed more than 4,000 companies before finally selecting Saepio. The choice was understandable for two entrepreneurs seeking to acquire a growing company, with Saepio having a client base of more than 700 UK companies and recording a 46 per cent increase in sales, along with a 32 per cent uplift in EBITDA, in 2023.

During the acquisition, Aurias engaged chartered accountants Saffery to undertake financial due diligence, along with advisory services such as tax structuring. Saffery reported to Aurias, along with its strong investor base, which included Ethos Partners, Miramar Equity Partners and Maven Equity Partners. Saffery also worked with Dunport Capital Management, which supported the acquisition through a debt facility.

Following the acquisition, Cardenas-Clark and Nooriala took over as co-CEOs of Saepio, with the company’s founders remaining on the board. After taking control of the company, the new CEOs plan to build upon Saepio’s growth by providing additional services and targeting international expansion.

As well as highlighting the potential success that can be attained through targeting an acquisition through a search fund, the deal also illustrates the huge amount of work that goes into finding the right target, as well as the significant amount of advisory and financial assistance that search fund entrepreneurs may need to complete an acquisition.

The issues behind the headlines

Are the funds really committed?
Perhaps the most pressing problem with ETA and search fund buyers (certainly from a vendor perspective) is whether they actually have the funds to go through with a transaction. The nature of most search funds is that investors provide the initial financing to support entrepreneurs through the research and target identification phase and only commit the actual finances to complete a transaction once a target has been identified and due diligence completed.

As a result, it may be difficult (and perhaps impossible) for many search fund buyers to be able to show a potential vendor proof of funds, rather they may have to simply demonstrate that they have willing investors that have committed to funding a deal.

This could, naturally, prove problematic in negotiations. For buyers, they clearly risk not being taken seriously by vendors if they are unable to prove that they actually have the funds necessary to do the deal.

For sellers that are willing to trust that the committed investors will stump up the cash, on the other hand, there is a degree of risk that this may not happen and that they waste time that they could have spent engaging with another buyer.

According to Candor Advisors, an inability to close deals once they have been agreed is a persistent problem for search funds. Candor claims that difficulties securing financing and completing transactions affect many search fund leaders, often resulting in deals falling apart even after Letters of Intent (LOIs) have been signed and due diligence processes undertaken - wasting valuable vendor time.

While providing proof of funds may be an inherent issue of the search fund model, vendors can potentially mitigate the risk by carefully vetting search fund buyers to ensure they have serious investors (for example, by confirming that the entrepreneur is being well paid during the search period).

The true failure rate
While there are a growing number of genuinely impressive ETA/search fund success stories, and the success rate of completed deals is notable, this unfortunately does not give the full picture of the challenges buyers seeking to use this route face, or the risks posed to buyers, investors and sellers.

Fundamentally, according to the 2024 Stanford study, more than half of all search funds fail. 37 per cent fail to find a business, a further 19.5 per cent fail to generate a return on investment, while another 5 per cent lose all their equity.

Analysing the key reasons for the failure of search fund deals, A.J. Wasserstein, a senior lecturer at Yale School of Management, came up with three key categories of failure that often impact search funds.

Firstly, “no-dealers”. These are the search fund entrepreneurs that never find a company. While this is frustrating given the significant work that entrepreneurs put into research and raising the funds to begin their search, it ultimately reflects a short-term loss and minimal financial damage.


Secondly, are “imploders”. Imploders go through the process of raising search funds, finding a company, negotiating a deal and raising funds to ultimately complete the deal, only for the venture to fail soon after the takeover has gone through. Clearly, this represents a far more significant loss of money, time and reputation than failing to find a company, but, as Wasserstein points out, doesn’t involve an entrepreneur sinking years of their career into a failing company.

The third category, “drifters”, represents perhaps the worst case scenario. According to A.J. Wasserstein, a major problem that tends to dog entrepreneurs operating through search funds is an inability to accept failure, which can lead to them sticking with businesses long after the prospect for success has passed.

He commented: "Our data says that entrepreneurship through acquisition CEOs and investors hang on to floundering businesses for too long.”

"If a drifter runs a business for five to ten years in perpetual anticipation of breaking out the next year, time becomes fleeting. If a searcher is a decade into a project at 45 years old with no equity to show for their efforts, they understandably feel frustrated and disappointed."

Naturally, such a stagnant investment will have serious implications for the returns for both entrepreneurs and investors, the owner’s lifetime earnings, their professional achievements, future opportunities and even health.

Exit woes
Wasserstein also highlighted the issues that search fund entrepreneurs can encounter when they finally exit - even if they have managed to make a success of the investment and been able to grow the company during their time in charge.

Fundamentally, Wasserstein says, entrepreneurs rarely achieve the kind of payday that they hoped to when they first set out. “Many entrepreneurs”, he says, “fantasize about a $10 million payday.”

In reality, however, the 2022 Stanford report highlighted that just 16 per cent of search fund entrepreneurs achieve an exit valued at over $10 million, with the average for those that manage to make an exit being $5.7 million.

While this is not necessarily a disaster, it would certainly be a major disappointment to any entrepreneur to pour 5, 7 or even ten years of their professional lives into building a company, only to barely achieve half of the initial valuation they were aiming for.

Even when they are ready to exit and are attracting interest from buyers, search fund entrepreneurs may find that it is harder to extricate themselves from the business than they had originally assumed.

According to a study carried out by A.J. Wasserstein, more than three-quarters of search fund sales are to private equity firms or private equity-backed platform companies.

On the one hand, growing a micro or small business to the point that it is attracting private equity interest is a genuine reflection of impressive work in growing and scaling up the business and will likely represent a significant payday for the entrepreneur and their investors.

However, unlike when search fund entrepreneurs take over a company, private equity buyers are more likely to insist as part of the deal that the original owner sticks around post-sale and maintains involvement in the business.

According to the data, 65 per cent of exiting searchers roll 25 per cent to 49 per cent of their equity. Additionally, they need to stay with the acquirer for approximately two years.

This could be problematic for an owner in a number of ways. Fundamentally, having to remain with the business and being unable to cash in their full equity following a sale will prevent them from moving on and, say, acquiring another business.

Secondly, whereas they had previously answered to a limited team of trusted investors (or even a single investment partner), working under a private equity firm is potentially far more demanding. In his study, Wasserstein found that new private equity owners have a net promoter score of negative 33 - indicating that search fund entrepreneurs who sell to private equity are often unhappy.

Conclusion
It’s easy to see why coverage of solo entrepreneur buyers and search fund successes is becoming so common, they make for great stories and the model does seem to deliver strong returns if an appropriate acquisition is made.

However, that “if” is the issue, as the vast majority of coverage focuses on the inspirational successes of the ETA model. But these are hardly representative of what the reality will be for the average would-be entrepreneur who seeks to buy a business through a search fund - no matter how experienced or capable they are.

This is not to suggest that the ETA model or search fund acquisitions are just a fad or that people who are genuinely serious about pursuing ownership through the ETA model shouldn’t explore the possibility, rather a reflection of the scale of the task and the considerable risk of failure.

For business sellers, there is a chance that ETA/search fund buyers could offer a valuable exit option, one that would most likely enable them to make a full exit without a lengthy transition period.

However, the risk that comes with trusting a buyer who doesn’t have proof of secured funds is considerable, meaning that rigorous due diligence is required when engaging with any buyer operating through a search fund.

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