The emergence of search funds has transformed the landscape of entrepreneurship and private capital in the small to middle market, creating a unique avenue for both investors and aspiring business operators. Search funds, typically structured as private investment vehicles, are raised by entrepreneurs (called “searchers”) seeking to acquire and manage a single, profitable business, usually in the small to middle market segment. Initially pioneered in the 1980s, search funds have become increasingly popular as a path to entrepreneurship and an asset class in private capital over recent years.

Search funds represent a niche but rapidly expanding asset class in the private equity market, particularly attractive for investors targeting small to middle market companies. Despite the growing interest and the impressive returns associated with this investment approach, search funds remain a small segment within the overall private equity landscape. According to recent data, traditional private equity assets under management (AUM) surpassed $4 trillion, while the cumulative capital raised by search funds is significantly smaller, estimated at around $1 billion by 2022. While exact figures are challenging to pinpoint, search funds occupy less than 1% of the private equity market, but their influence is disproportionately high due to unique strategic advantages and increasing institutional interest.

The allure of search funds for both entrepreneurs and investors lies in the hands-on ownership model, which allows emerging entrepreneurs to acquire, operate, and grow a business within the lower middle market. This structure is highly appealing to private equity firms that see it as a way to tap into more granular opportunities in this underserved sector, with a relatively low initial capital outlay compared to larger buyouts. For example, search funds typically target companies with earnings before interest, taxes, depreciation, and amortization (EBITDA) of $0.5 million to $5 million, contrasting with the higher revenue thresholds in traditional private equity acquisitions.

Investors are increasingly attracted to the potential returns from search funds, which have been shown to outpace other private equity asset classes. A Stanford study found that search funds had a 5.5 times return on capital invested, significantly outperforming typical growth equity or buyout returns. The focused nature of search funds, combined with the operational involvement of the searcher-turned-CEO, allows for potentially high returns, though at the risk of investing in a single business rather than a diversified portfolio typical of traditional private equity funds.

Wrap-up: Search funds are still a minor component of the private equity landscape in terms of volume, their growth potential and unique approach to value creation are drawing considerable interest, especially among investors focused on smaller, growth-oriented businesses. This trend suggests that search funds could continue to increase their share of the private equity market as more investors and entrepreneurs recognize the potential for hands-on, high-impact investments in this space.