Traditional search fund turned self-funded

searcher profile

November 06, 2023

by a searcher from The University of Michigan - Stephen M. Ross School of Business in New York, NY, USA

How would it work if a dual search team were to raise a traditional search fund and then find a deal that would allow them to retain higher equity percentage by leveraging an SBA or other non-dilutive funding? How would this impact the ROFR in place with the initial investors?

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commentor profile
Reply by an investor
from University of the Sunshine Coast in Brisbane QLD, Australia
It would come down to the shareholder's agreement. If your motivation to switch to self-funded is to obtain a larger piece of the pie, you wouldn't be acting with the same intentions as the original traditional search fund set out.

You may have to buy out the original traditional investors and establish a new fund.

It's similar to if I was to establish a managed investment fund that stated to all investors that I was going to act in their best interests and I will use the capital to invest 100% in Real Estate. Then I decide that Real Estate isn't the best option and I am going to use 50% of it for early stage startups. The IM clearly says that I will be investing in Real Estate. If I was to then invest in Early State Startups then I would not be aligning actions with the IM. (In Australia, that is illegal)

Basically, it's going to require some conversations with your investors to see if you can strike a deal that is worth it for all parties or not.
commentor profile
Reply by a professional
from University of Toronto in Toronto, ON, Canada
It doesn't work at all! You accepted funding from the traditional search fund but now you want to cut them out of the deal because you can get a better return for yourself doing it a different way. That's a serious conflict of interest. To remove that problem, you would have to return the funding provided by the traditional search fund (probably with some sort of bonus to cover their opportunity cost) and get a waiver from them or other form of termination of your relationship to avoid liability. In addition, think about your reputation risk: this isn't a good look for you to wear as a dealmaker, and the search fund community is small and word gets around easily and quickly. You don't want to be branded as an untrustworthy partner.
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