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Business

Why Many Entrepreneurs Are Turning to a ‘Search-Fund’ Model

The business model is new but increasingly popular.
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Inside the lobby bar at the W Dallas-Victory Hotel, investor/CEO Nick Padlo was sharing advice and entrepreneurial war stories one recent afternoon with Simone and Malcolm Collins, an ambitious young married couple that’s looking to acquire and run a business. Related through Malcolm to Dallas’ prominent Collins family—the late Jim Collins was Malcolm’s grandfather—Simone, 29, and Malcolm, 30, are intent on acquiring an established company using what’s called the “search-fund” model.

Also known as “entrepreneurship through acquisition,” the relatively new but increasingly popular business model involves raising a pool of capital from investors in order to locate and acquire an existing, privately held company. The objective: managing and growing the company toward a lucrative exit while providing the investors with a healthy return. The method was developed in the 1980s at the Stanford Graduate School of Business in Palo Alto, Calif., where Malcolm graduated with an MBA degree in 2015. Padlo, managing partner at Dallas-based search fund Graycourt Capital and a former U.S. Army intelligence officer, also is a Stanford MBA. He used the search-fund model to found Euless-based The Pet Loss Center, where he’s now the CEO.

Last spring Padlo advised the Collinses on fundraising techniques, and the couple was able to secure $600,000 from 17 investors for the search part of their quest, which could last as long as two years. Once they identify a company to buy—they’re looking now at targets with $5 million to $50 million in annual revenue, in a variety of industries—their investors will serve as advisers and have first-refusal rights to pony up the cash required to make the acquisition. According to Stanford, hundreds of search funds have been raised and closed over the last three decades. University researchers found that, through year-end 2015, the “aggregate pre-tax internal rate of return of the search fund asset class was 36.7 percent, and the aggregate pre-tax return on invested capital is 8.4 [times].” The Collinses estimate there are now more than 80 active U.S. search funds.

One of the investors in Padlo’s fund is Andy Love of Aspect Investors LLC, another Stanford MBA who used the search-fund model to co-found Behavioral Health Group, a substance-abuse treatment company, in Dallas in 2006. “Because of its central location and pro-business environment, Dallas is a great place for search funds,” Love says. The model “offers a great way to go after lower to lower-middle-market companies—companies that aren’t quite right for traditional private equity.”

Last May, for one example, Irving-based HousingWire, a media company specializing in the housing industry, was acquired by a search fund called Riomar Capital. Meantime, the Collinses are continuing their quest for a company to buy, making 20 to 50 “cold calls” a week to businesses focused on everything from apparel to healthcare. They hope the company they settle on will be located in Dallas, but they’re not married to the idea. “At the end of the day,” Malcolm says, “we’ll take a deal anywhere.”        

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