Search Fund LP Investing For Non-Institutional LPs

I sit on both sides of the search fund table. I back searchers as an LP, and I have spent enough time evaluating the model that I have developed strong opinions about how non-institutional LPs should think about the asset class. Most of the standard search fund pitch is structured for institutional LPs. The math and the trade-offs look different when you are an individual writing a single check rather than a fund running a portfolio.

What you are actually investing in

The first round of search fund capital, often called the search round, funds the principal's salary and search expenses for typically eighteen to twenty-four months. The check is small (usually thirty to fifty thousand per LP unit) and the return mechanism is a step-up to the acquisition round if and when the searcher closes a deal.

The second round, the acquisition round, funds the actual purchase of a business. LPs in the search round get a preferential allocation in the acquisition round. New LPs may also come in. The economics from this point forward look like a private equity investment in a single SMB.

What the returns look like

Reported aggregate returns on search funds have historically been strong, in the low-to-mid thirty percent IRR range across the industry. The catch is that the distribution is not uniform. A meaningful fraction of searchers never close a deal, in which case the search round capital is largely lost. Of those who do close, returns vary widely based on the underlying business performance and the operator's execution.

For an institutional LP running a portfolio of search funds, the math works because the winners cover the misses. For a non-institutional LP making a single bet, the variance is the dominant feature, not the aggregate average.

How I think about it as a non-institutional LP

I do two things differently than the typical search fund LP playbook. First, I diligence the principal more rigorously than a typical institutional LP would. The aggregate IRR is not my IRR. My IRR depends on whether this specific principal closes a good deal, which depends on their judgment, network, and operating instinct.

Second, I think hard about the deal-by-deal alternative. Some searchers structure deal-by-deal commitments instead of (or alongside) traditional search funds. The trade-off is more diligence work per opportunity, but the LP only deploys capital when a real deal is on the table.

What I tell other LPs

If you are committing to your first search fund as a non-institutional LP, do not commit thinking the historical aggregate returns are your expected returns. Commit because you have done the work to back this specific principal, you understand the variance, and you can absorb the case where the search round capital is lost without it changing your financial life.

The math works. Just not for everyone, and not on every deal.