Search Fund Economics From The LP Side

Most search fund pitch materials are written for searchers and institutional LPs. The economics get presented in a way that is technically accurate but glosses over a few features that matter to a non-institutional LP. Here is the LP-side math, with the parts I think get under-discussed.

The two-stage capital structure

A traditional search fund deploys capital in two stages. The search round funds the searcher's salary and search expenses for typically eighteen to twenty-four months. LPs in the search round commit a small amount (usually thirty to fifty thousand per unit) and receive a step-up multiplier on their capital when it converts into the acquisition round.

The acquisition round funds the actual purchase of a business. The search-round LPs have a preferential right to participate. New LPs may also come in. The economics from this point forward look like a private equity investment in a single SMB.

The aggregate IRR is not your IRR

The aggregate IRR figures published for the search fund asset class as a whole tend to be in the low-to-mid thirty percent range. The number is real and it is the result of a portfolio effect. Searchers who close successful deals produce returns that compensate for the searchers who never close one.

A non-institutional LP making a single bet is exposed to the variance of one outcome, not the aggregate average. If the searcher does not close a deal, the search round capital is largely lost. If the searcher closes a poor deal, the acquisition round capital can underperform significantly. If the searcher closes a strong deal and operates it well, the LP makes the kind of return the aggregate figures suggest.

The hold period

Search funds typically aim for a five to seven year hold from the acquisition. That assumes the searcher closes a deal within the first eighteen to twenty-four months of the search round. Total capital lockup from the LP's perspective is therefore seven to nine years.

That length of lockup matters. It is comparable to a private equity fund commitment, but the diversification a fund provides is absent.

Carry and economics for the searcher

The searcher's compensation usually has three components. A salary during the search and operating period. An equity stake that vests on three time- and performance-based tranches. A carry on the eventual exit, often around ten percent of the equity value above a defined hurdle.

The economics are designed to align the searcher with the LPs over a long horizon. They also give the searcher meaningful upside that the LPs are funding. Both are reasonable. Just understand that you are funding the searcher's compensation as part of the structure.

How I approach my own search fund LP positions

I diligence the principal more rigorously than the typical institutional LP would, because I am exposed to one outcome rather than a portfolio. I focus my search-fund LP commitments on principals where I have direct conviction, including from prior working relationships or from extensive shared-network reference checking.

I also reserve some allocation for deal-by-deal co-invest opportunities, where I deploy capital only when a specific deal is on the table that I have evaluated and want to back.

The honest summary

The asset class produces strong aggregate returns. Single-bet variance is high. The lockup is long. The economics work for searchers, institutional LPs running portfolios, and individual LPs who have done the work to back specific principals.

Just make sure you are signing up for the right version of the bet.