Search Fund vs Independent Sponsor Fundamentals

January 05, 2020

by a searcher from University of Pittsburgh - The Joseph M. Katz Graduate School of Business in Pittsburgh, PA, USA

Brand new searcher here. I'm having a difficult time understanding the fundamental/structural differences between the Independent/Unfunded Sponsor and the Search Fund model.

Am I correct in understanding the main difference is that the search fund model is fundamentally designed to fund/bridge the search period for the principal, incentivizing initial investors through step-up's and preferential deal-level investment, while the Independent Sponsor model requires self-funding of initial 'survival' capital but is similar in other regards?

Thinking longer-term, would it be reasonable to assume that once an initial search-fund backed deal was exited, assuming profitably, a principal would likely move towards an Independent Sponsor or self-funded model for their next deal or deals?

Thanks in advance for any help along this new journey.

Reply by a searcher
from University of Pittsburgh in Pittsburgh, PA, USA

^redacted‌ Thanks, ^redacted‌. I’ve read a couple of pieces on Axial but the link you sent is very helpful. It sounds like the real, ‘philosophical’ difference between the models really comes down to intent. More specifically, ‘operating’ one company rather than ‘managing or overseeing’ multiple company(s). Cutting through the semantics, if a principal or manager has a framework for success that they believe in, what incentive is there to structure a vehicle that limits them to one company, rather than implementing a successful strategy in say, two or three companies?

That leads to the next point of thought - If:

1. The search fund model provides funding for the search phase, provides investors with the direct-deal level investing and is designed to place a manager in charge of one company.

and

2. The independent sponsor model does not explicitly fund the search phase, provides investors access to direct-deal investing, and is intended to place management over a portfolio of companies.

Is there not a common hybrid designed to fund the initial search, provide direct deal level investing, and oversee a portfolio of companies?

Effectively, what I think I’m envisioning is a ‘micro-PE’ concept, raising initial search capital with the intent to invest in several target deals within which the management would be directly involved in managing with the intent to successfully exit with carried interest.

Please forgive me if I’m off badly off base somewhere! Truly appreciate you guys helping to educate me more on this.

Reply by a searcher
from The University of Michigan in Detroit, MI, USA

I've had similar fundamental questions regarding the differentiation between traditional search funds and independent sponsor models for new "searchers". I've been in the M&A industry for a short period of time on both the buy and sell side and having the flexibility to invest in multiple businesses through an independent sponsor model seems particularly attractive once I finish my MBA. However, while I've seen a great deal of investor activity surrounding traditional search investments with recent MBA grads, I have seen much less activity in new independent sponsor models.

I'm starting to think that raising capital through an independent sponsor model right off the bat is unrealistic for an "inexperienced" searcher. Is it generally the case that you have to prove yourself through a traditional search fund investment in order to raise money for more acquisitions later on? Conversely, are there investor groups that would be willing to invest in a new searcher that intends to acquire companies where the management team stays in place so the searcher could continue to acquire other companies to add to the portfolio?

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