# Search Fund Concept Card: [Your name, elective or search, and date] > An elective-level concept card for entrepreneurship through acquisition (ETA): the search fund, in which a > first-time chief executive raises a small pool of search capital, spends up to about two years looking for one > profitable private company, buys it with debt and equity from the same investors, and runs it until a sale. It > covers search economics, the step-up on search capital, target screening, the acquisition structure, the > searcher's equity in three tranches, the exit waterfall and returns to investors and searcher. It builds on > mba/mba-paper-lbo and mba/mba-lbo-model-card and does not re-teach the leveraged buyout mechanics. It is for MBA > students in an entrepreneurship or private equity elective, prospective searchers deciding between a traditional, > self-funded or accelerator search, and investors in search funds. Worked example A follows a fictional search from > search capital to exit, Worked example B is half solved with a lower growth path, and Exercise C asks for the > maximum price and a downside. Source basis: the Stanford Graduate School of Business search fund study series > (2026 Search Fund Study: Selected Observations, case E967, data to 31 December 2025), Jensen (1986) and Kaplan and > Stromberg (2009), written up in original words with fictional numbers. Dated market statistics carry their source > and a "check before you rely on it" line. Replace every [bracketed] value and every row marked *Example*. This is a > learning aid, not investment, legal, tax or career advice. ## Document control | Field | Value | |---|---| | Learner or searcher | [Your name] | | Elective, search or deal | [Entrepreneurship elective, search fund name, target name] | | Search model | [Traditional, self-funded, accelerator or incubator, solo or partnership] | | Term sheet basis | [Whose terms: investor group, school template, your own draft] | | Market statistics checked on | YYYY-MM-DD | | Reviewed by | [Learning team member, teaching assistant, search fund investor or mentor] | | Version | [0.1] | | Last updated | YYYY-MM-DD | ## Contents - [When to use it](#when-to-use-it) - [The idea in plain language](#the-idea-in-plain-language) - [Formulas and notation](#formulas-and-notation) - [Search economics as of October 2026](#search-economics-as-of-october-2026) - [Assumptions and limits](#assumptions-and-limits) - [How searchers and investors use it](#how-searchers-and-investors-use-it) - [The search step by step](#the-search-step-by-step) - [Target screening criteria](#target-screening-criteria) - [Worked example A (fully solved): the Okafor search and Brenholt Field Services](#worked-example-a-fully-solved-the-okafor-search-and-brenholt-field-services) - [Worked example B (half solved): a slower growth path](#worked-example-b-half-solved-a-slower-growth-path) - [Exercise C (unsolved): maximum price and a downside](#exercise-c-unsolved-maximum-price-and-a-downside) - [Connections to other cards](#connections-to-other-cards) - [Common mistakes and misconceptions](#common-mistakes-and-misconceptions) - [Self-test questions](#self-test-questions) - [My notes and next steps](#my-notes-and-next-steps) - [Sources and further reading](#sources-and-further-reading) - [Answer key](#answer-key) ## When to use it Use this card when: - you are deciding after an MBA between joining a company, starting one from an idea, or buying one, and you need to understand what the acquisition route pays, how long it takes and how often it fails; - you are preparing a search fund pitch to investors and must explain the search budget, the step-up and the equity you will earn; - you have found a target and need a first view of price, debt capacity and returns before a letter of intent; - you are an investor or a student in a private equity elective comparing a search fund deal with a sponsor-led buyout of a similar company; - a case in an entrepreneurship or private equity course asks you to judge whether a searcher should pay the seller's asking price. Do not use it as a valuation of a specific business without due diligence, and do not treat the aggregate returns of the study series as the expected return of one search: the distribution is wide and skewed. ## The idea in plain language A traditional search fund has two stages. In the **search stage**, one or two people, often recent MBA graduates with little or no prior operating experience as a chief executive, raise a small amount of search capital from a group of investors (individuals, search fund specialist funds, former searchers). The capital pays a modest salary and the costs of finding a company: travel, data, legal and accounting work on early deals. Investors buy the search capital in units, and each unit gives them the right, not the obligation, to invest in the acquisition later. In the **acquisition and operating stage**, the searcher finds a stable, profitable private company, often one whose founder is retiring and has no successor. The searcher negotiates a price, arranges senior debt from a bank or credit fund and often a seller note from the founder, and offers the equity to the search investors first. Investors who join convert their search capital into acquisition securities at a premium, the **step-up** (commonly 1.5 times the amount invested in the search), which compensates them for funding a search that might have failed. The searcher becomes chief executive and runs the company, usually for several years, until a sale or a recapitalisation. The searcher puts in little or no money but earns a large share of the common equity, traditionally about a quarter of it, in three equal tranches: one at the acquisition, one that vests over the years of service, and one that is earned only if investors achieve a stated return. The structure is a bet on the person: investors fund a talented but untested manager, and the manager earns ownership by doing two hard things, buying well and running well. Why does the model work? A small, stable company with a retiring owner often sells for a lower multiple of earnings than a larger company: there are fewer buyers, the business depends on the founder, and its information is informal. A full-time, well-advised buyer can capture part of that discount, add moderate leverage, professionalise the company and grow it, and later sell a larger, less founder-dependent business to a buyer who pays a higher multiple. Jensen (1986) explains why concentrated ownership with debt can discipline management, and Kaplan and Stromberg (2009) group the sources of buyout value into financial, governance and operational engineering. In a search fund the operational part carries most of the weight, because the searcher is also the chief executive. Why does it fail? Many searches end without an acquisition, some acquisitions lose money, and the searcher's first years as chief executive are a steep learning curve. The aggregate returns reported by the Stanford study are high because a minority of deals return many times the capital, and an investor who backs only a few searches can easily miss them. ## Formulas and notation Search capital $K_s$ converts into acquisition securities at the step-up $u$: $$ K_s^{credit} = u \cdot K_s \qquad \text{(for example } u = 1.5\text{)} $$ Sources and uses at the acquisition, with enterprise value $EV_0 = m_{entry} \cdot EBITDA_0$, transaction costs $F$ and cash put on the balance sheet $C_0$: $$ EV_0 + F + C_0 = D_{senior} + D_{seller} + E_{new} $$ Investors' preferred securities have a face value $P$ equal to the new equity plus the credited search capital: $$ P = E_{new} + K_s^{credit} $$ Equity at exit after year $N$, with exit multiple $m_{exit}$: $$ E_N = m_{exit} \cdot EBITDA_N - D_{senior,N} - D_{seller,N} + Cash_N $$ Waterfall: investors first receive the face value of the preferred, then the common equity $Q$ is shared. The searcher earns tranches $T_1$ and $T_2$ (each a share $\sigma/3$ of common) for the acquisition and for time served, and the performance tranche $T_3$ only to the extent investors still reach the hurdle IRR $h$: $$ Q = \max(0,\; E_N - P) \qquad T_1 = T_2 = \frac{\sigma}{3} Q \qquad T_3 = \min\left(\frac{\sigma}{3} Q,\; \max\left(0,\; E_N - T_1 - T_2 - V_h\right)\right) $$ where $V_h$ is the exit value investors need to earn exactly $h$ on all their cash, with search capital paid $S$ years before the acquisition: $$ V_h = K_s (1+h)^{N+S} + E_{new} (1+h)^{N} $$ Investor proceeds and IRR, including the search period: $$ X_{inv} = E_N - T_1 - T_2 - T_3 \qquad 0 = -\frac{K_s}{(1+IRR)^{0}} - \frac{E_{new}}{(1+IRR)^{S}} + \frac{X_{inv}}{(1+IRR)^{S+N}} $$ Stylised value of one search unit, with acquisition probability $p$ and multiple $M$ on acquisition securities (ignoring timing): $$ \mathbb{E}[\text{multiple on search capital}] \approx p \cdot u \cdot M $$ | Symbol | Meaning | Note | |---|---|---| | $K_s$, $u$, $K_s^{credit}$ | Search capital, step-up, credited value | Step-up of 1.5x is a common convention, not a rule | | $EV_0$, $m_{entry}$, $EBITDA_0$ | Purchase enterprise value, entry multiple, last-twelve-month EBITDA | Use quality-of-earnings adjusted EBITDA | | $F$, $C_0$ | Transaction costs, cash to balance sheet | Legal, accounting, financing fees | | $D_{senior}$, $D_{seller}$ | Senior debt, seller note | Seller note is subordinated and often repaid at or near exit | | $E_{new}$, $P$ | New cash equity at acquisition, face value of investors' preferred | In this card the preferred carries no coupon | | $E_N$, $Q$ | Equity at exit, common equity after the preferred | | | $\sigma$, $T_1$, $T_2$, $T_3$ | Searcher's total common share and its three tranches | This card uses $\sigma = 25\%$ | | $h$, $V_h$ | Investor hurdle IRR for the performance tranche, value needed to reach it | This card uses $h = 25\%$ | | $S$, $N$ | Years of search, years of ownership | This card uses $S = 2$, $N = 5$ | | $p$, $M$ | Probability a search acquires, multiple on acquisition securities | Stylised, for intuition only | Excel: with cash flows in B2:I2 (year minus 2 to year 5), investor IRR is `=IRR(B2:I2)`; the hurdle value is `=Ks*(1+h)^(N+S)+E_new*(1+h)^N`; the performance tranche is `=MIN(sigma/3*Q,MAX(0,E_N-T1-T2-V_h))`. ## Search economics as of October 2026 The Stanford Graduate School of Business has published a search fund study roughly every two years since the 1990s, covering traditional search funds in the United States and Canada. The 2026 edition is *2026 Search Fund Study: Selected Observations* (case E967, data to 31 December 2025), listed at https://www.gsb.stanford.edu/faculty-research/case-studies/2026-search-fund-study-selected-observations. The official pages refused automated access when this card was written, so the figures below come from a Stanford Insights article of 13 July 2026 (as quoted in search results) and from secondary summaries published in July 2026. Treat them as reported, not confirmed, and check the study. | Item | Reported figure (check before you rely on it) | Source route | |---|---|---| | Coverage | More than 850 traditional search funds in the US and Canada; one summary counts 862 launched from 1984 to 2025 | Stanford Insights summary; secondary summary | | Acquisition rate | Nearly 60% of search funds acquire a company, typically within two years; one summary reports 58% of concluded searches all time and about 48% for the 2021 to 2024 cohorts | Stanford Insights summary; secondary summary | | Aggregate returns | Pre-tax aggregate IRR of about 33.9% and return on invested capital of about 4.75x, to 31 December 2025 | Secondary summaries of the study | | Skew | Returns are concentrated in a minority of outlier deals; one summary estimates that about a quarter of acquired companies lose capital | Secondary summary | | Typical deal, 2024 to 2025 | Median purchase price about USD 16 million enterprise value, median EBITDA about USD 2.5 million, purchase multiple about 6.2x EBITDA | Secondary summary | | Search capital | Median about USD 550,000, a record high | Secondary summary | What follows for a learner: the aggregate return is a pooled figure across all deals, weighted by capital, and is driven by a few large outcomes. It says that the asset class has worked for diversified investors; it does not say that a given search will earn 34% a year. For the searcher, the relevant numbers are the chance of acquiring, the time it takes, and the distribution of outcomes for a first-time chief executive. Some business schools also study searches outside the US and Canada, where deal sizes, debt markets and seller attitudes differ; check whether a study exists for your region. ## Assumptions and limits - **Preferred without a coupon.** This card's preferred securities return their face value before common equity and carry no accruing dividend. Many search fund preferred securities accrue a yield or participate differently; an accruing preferred lowers the common equity and therefore the searcher's share. - **Step-up of 1.5x applied to all search capital.** Terms vary, and some groups apply the step-up only to investors who fund the acquisition pro rata. - **Searcher's share of 25% in three equal tranches.** Traditional terms cluster around this, but secondary summaries report ranges of about 20% to 35% for different models; partnerships of two searchers share the same pool. - **Performance tranche with a cap at the hurdle.** This card earns the third tranche only to the extent investors still reach a 25% IRR on all their cash. Real terms often use a sliding scale between two IRR levels, measured differently; read the term sheet. - **Interest on opening balances, 100% cash sweep to senior debt.** Seller notes in this card pay cash interest and are repaid at exit. In practice seller notes may be subordinated with payment blocks, earn-outs or standstill provisions. - **No interim distributions, no refinancing, no add-on acquisitions.** Each would change the timing of cash flows and the IRR. - **Pre-tax returns.** Taxes on the searcher's equity depend on the form of the securities and the jurisdiction. - **Legal setting.** Raising search capital and acquisition equity is a securities offering in most jurisdictions, and government-guaranteed small-business loans (in the US, the Small Business Administration 7(a) programme) have their own equity and seller-note rules. These change; check the current rules with a qualified lawyer. ## How searchers and investors use it | Reader | Question | Outputs they look at | |---|---|---| | Searcher | Can I afford this price, and what will I earn in the base and downside cases? | Sources and uses, debt service cover, searcher tranches by case | | Search investors | Is this the company and the price to back with a step-up, and how does the searcher earn the equity? | Entry multiple, quality of earnings, waterfall, investor IRR including the search period | | Gap investors (new equity at acquisition) | Am I paid enough for coming in without the search risk? | Investor IRR on acquisition equity only, share of the preferred | | Senior lender | Can the company service and repay the debt with a first-time chief executive? | Leverage, interest cover, free cash flow, seller note subordination | | Seller | Is the buyer credible, and how much of the price is deferred? | Cash at closing, seller note terms, transition role | | Board (investors plus independent members) | Is the searcher learning fast enough, and when should we sell? | Monthly results against plan, leverage, value bridge | Search investors usually sit on or appoint the board after the acquisition, and experienced investors coach the new chief executive. That governance is part of the product: it is how an untested manager gets support (see mba/mba-corporate-governance-card). ## The search step by step A search moves through fundraising, sourcing, screening, the letter of intent (LOI), diligence and financing, closing and transition, and then operation and exit. Most searches that fail run out of time or money between the LOI and closing, when diligence uncovers problems or the seller changes their mind. ```mermaid flowchart TD A["Raise search capital in units"] --> B["Define criteria: industry, size, margin, geography"] B --> C["Source: owner outreach, brokers, networks"] C --> D["Screen: recurring revenue, margins, customer concentration, owner transition"] D -->|"Fails screen"| C D --> E["Letter of intent: price, structure, exclusivity"] E --> F["Diligence: quality of earnings, legal, customers, people"] F -->|"Deal breaks"| C F --> G["Arrange senior debt and seller note"] G --> H["Offer acquisition equity to search investors first, step-up applies"] H --> I["Close, searcher becomes chief executive, tranche 1 earned"] I --> J["Operate: board, value creation plan, tranche 2 vests"] J --> K["Exit or recapitalisation: waterfall, tranche 3 tested against hurdle"] C -->|"Time or capital runs out"| L["Search ends without acquisition"] ``` ## Target screening criteria A traditional search fund looks for a company that a first-time chief executive can run without breaking it. The criteria below are typical of how investors and searchers describe a good target; set your own thresholds. | ID | Criterion | Why it matters | Example threshold (*Example*) | |---|---|---|---| | SC-01 | Stable, recurring or repeat revenue | Predictable cash flow supports debt and forgives early mistakes | Over 60% of revenue from repeat customers or contracts | | SC-02 | Attractive margins and low capital intensity | Free cash flow repays debt; low capex leaves room for growth | EBITDA margin over 15%, capex under 3% of revenue | | SC-03 | Fragmented, growing or stable industry | Room to grow organically or by add-ons without a dominant competitor | Industry growth at least in line with GDP | | SC-04 | Low customer and supplier concentration | One lost customer should not sink the company | Largest customer under 15% of revenue | | SC-05 | Owner transition is the main issue | The reason for sale should be succession, not decline | Founder retiring, no family successor | | SC-06 | Simple to understand and manage | The searcher must learn the business quickly | No regulated licence held personally by the founder | | SC-07 | Size fits the debt and equity available | Too small does not pay the team; too large outruns the investors | EBITDA of USD 1.5 million to USD 5 million | | SC-08 | Clear improvement levers | The value creation plan needs specific, owned actions | Pricing, sales process, systems, add-on targets | | SC-09 | Second-layer management or the ability to hire it | The founder's knowledge must not leave on day one | At least one manager who can run operations | | SC-10 | Price discipline | A great company at the wrong price is a bad deal | Entry multiple at which the base case clears the hurdle | Score each company 1 to 5 on SC-01 to SC-09 and record the maximum price from your model as SC-10. Kill a deal early when SC-04 or SC-05 fails; those failures are hard to fix after closing. ## Worked example A (fully solved): the Okafor search and Brenholt Field Services *Example* inputs. Dana Okafor raises search capital of 14 units of USD 40,000 (USD 0.56 million) and searches for two years. She finds Brenholt Field Services, a fictional maintenance services company with revenue of 12.00 and EBITDA of 2.50 (margin 20.83%). She agrees a price of 6.0x EBITDA. Transaction costs are 4% of enterprise value; 0.30 of cash goes on the balance sheet. Senior debt is 3.0x EBITDA at 8.5%, with a 100% cash sweep; the seller note is 1.50 at 6% cash interest, repaid at exit. Search investors fund 4.60 of the new equity and a gap investor 2.30. Revenue grows 12% a year with a constant margin; depreciation and capex are 0.30 a year; net working capital is 10% of revenue; tax is 25% of EBITDA less depreciation and interest. Exit after five years at 7.0x EBITDA. The searcher's pool is 25% of common equity in three equal tranches; the performance tranche is capped at a 25% investor IRR on all cash. ### Step 1: step-up and sources and uses (USD m) Search capital credited: 0.56 x 1.5 = 0.84 (`=14*0.04*1.5`). | Uses | Amount | Sources | Amount | |---|---|---|---| | Purchase enterprise value (6.0 x 2.50) | 15.00 | Senior debt (3.0 x 2.50) | 7.50 | | Transaction costs (4% x 15.00) | 0.60 | Seller note | 1.50 | | Cash to balance sheet | 0.30 | New equity (search investors 4.60, gap investor 2.30) | 6.90 | | Total uses | 15.90 | Total sources | 15.90 | Total debt is 3.6x EBITDA (`=(7.5+1.5)/2.5`); new equity is 43.4% of sources (`=6.9/15.9`). Investors' preferred has a face value of 7.74 (`=6.9+0.84`): search investors hold 5.44 (70.28%) and the gap investor 2.30 (29.72%). ### Step 2: operating model and debt schedule (USD m) | Year | Revenue | EBITDA | Senior interest | Seller note interest | Tax | Increase in NWC | FCF | Senior repaid | Closing senior debt | |---|---|---|---|---|---|---|---|---|---| | 0 | 12.00 | 2.50 | | | | | | | 7.50 | | 1 | 13.44 | 2.80 | 0.64 | 0.09 | 0.44 | 0.14 | 1.19 | 1.19 | 6.31 | | 2 | 15.05 | 3.14 | 0.54 | 0.09 | 0.55 | 0.16 | 1.50 | 1.50 | 4.82 | | 3 | 16.86 | 3.51 | 0.41 | 0.09 | 0.68 | 0.18 | 1.85 | 1.85 | 2.97 | | 4 | 18.88 | 3.93 | 0.25 | 0.09 | 0.82 | 0.20 | 2.27 | 2.27 | 0.70 | | 5 | 21.15 | 4.41 | 0.06 | 0.09 | 0.99 | 0.23 | 2.74 | 0.70 | 0.00 | Year 1 in Excel: revenue `=12*1.12`; EBITDA `=13.44*2.5/12` = 2.80; senior interest `=8.5%*7.5` = 0.64; seller note interest `=6%*1.5` = 0.09; tax `=25%*(2.8-0.3-0.6375-0.09)` = 0.44; increase in NWC `=10%*(13.44-12)` = 0.14; FCF `=2.8-0.6375-0.09-0.44-0.3-0.144` = 1.19. In year 5 the senior debt is fully repaid with 0.70 and the remaining 2.04 builds cash, so cash at exit is 2.34 (`=0.3+2.74-0.70`). ```vega-lite { "$schema": "https://vega.github.io/schema/vega-lite/v5.json", "description": "Brenholt Field Services: closing senior debt and cash by year, USD m, computed example", "width": 420, "height": 240, "data": { "values": [ {"year": "0", "item": "Senior debt", "value": 7.50}, {"year": "0", "item": "Cash", "value": 0.30}, {"year": "1", "item": "Senior debt", "value": 6.31}, {"year": "1", "item": "Cash", "value": 0.30}, {"year": "2", "item": "Senior debt", "value": 4.82}, {"year": "2", "item": "Cash", "value": 0.30}, {"year": "3", "item": "Senior debt", "value": 2.97}, {"year": "3", "item": "Cash", "value": 0.30}, {"year": "4", "item": "Senior debt", "value": 0.70}, {"year": "4", "item": "Cash", "value": 0.30}, {"year": "5", "item": "Senior debt", "value": 0.00}, {"year": "5", "item": "Cash", "value": 2.34} ] }, "mark": "bar", "encoding": { "x": {"field": "year", "type": "ordinal", "title": "Year"}, "xOffset": {"field": "item"}, "y": {"field": "value", "type": "quantitative", "title": "USD m"}, "color": {"field": "item", "type": "nominal", "title": "Item"} } } ``` ### Step 3: exit waterfall (USD m) | Item | Computation | Result | Excel formula | |---|---|---|---| | Year 5 EBITDA | 2.50 x 1.12^5 | 4.41 | `=2.5*1.12^5` | | Exit enterprise value | 7.0 x 4.41 | 30.84 | `=7*2.5*1.12^5` | | Less seller note, plus cash | 30.84 - 1.50 + 2.34 | 31.68 | `=30.84-1.5+2.34` | | Preferred face value to investors | | 7.74 | `=6.9+0.84` | | Common equity Q | 31.68 - 7.74 | 23.94 | `=31.68-7.74` | | Tranches 1 and 2 (2 x 25%/3 of Q) | 23.94 x 16.67% | 3.99 | `=23.94*0.25*2/3` | | Hurdle value V_h at 25% | 0.56 x 1.25^7 + 6.90 x 1.25^5 | 23.73 | `=0.56*1.25^7+6.9*1.25^5` | | Investors before tranche 3 | 31.68 - 3.99 | 27.69 | `=31.68-3.99` | | Tranche 3 (full 2.00 fits above the hurdle) | MIN(2.00, 27.69 - 23.73) | 2.00 | `=MIN(23.94*0.25/3,MAX(0,27.69-23.73))` | | Investor proceeds | 27.69 - 2.00 | 25.70 | `=27.69-2` | | Searcher proceeds | 3.99 + 2.00 | 5.99 | `=3.99+2` | ### Step 4: returns | Holder | Cash in | Cash out | Multiple | IRR | Excel | |---|---|---|---|---|---| | All investors, including the search period | 0.56 in year -2, 6.90 in year 0 | 25.70 in year 5 | 3.44x | 26.9% | `=IRR({-0.56,0,-6.9,0,0,0,0,25.7})` | | All investors, acquisition equity only | 6.90 in year 0 | 25.70 in year 5 | 3.72x | 30.1% | `=RRI(5,6.9,25.7)` | | Search investors (70.28% of investor proceeds) | 0.56 in year -2, 4.60 in year 0 | 18.06 in year 5 | 3.50x | 26.8% | `=IRR({-0.56,0,-4.6,0,0,0,0,18.06})` | | Gap investor (29.72%) | 2.30 in year 0 | 7.64 in year 5 | 3.32x | 27.1% | `=RRI(5,2.3,7.64)` | | Searcher | none | 5.99 in year 5 | | | | The gap investor earns a slightly higher IRR than the search investors even without a step-up, because its money is invested two years later and carried no search risk. The step-up of 1.5x is what keeps the search investors' IRR close: without it (step-up 1.0x) their share of investor proceeds would be 69.17%, their IRR 26.4% and the gap investor's 28.0%. The step-up also raises the preferred face by 0.28, which lowers common equity by the same amount and costs the searcher 0.07 (5.99 against 6.06 with no step-up). ### Step 5: value bridge (USD m, equity before the waterfall) | Source | Computation | Contribution | |---|---|---| | EBITDA growth at the entry multiple | (4.41 - 2.50) x 6.0 | 11.44 | | Multiple expansion | (7.0 - 6.0) x 4.41 | 4.41 | | Senior debt repaid | 7.50 - 0.00 | 7.50 | | Cash built up | 2.34 - 0.30 | 2.04 | | Transaction costs | | -0.60 | | Equity gain over new cash equity | 31.68 - 6.90 | 24.78 | The judgement to state: growth under the new chief executive creates almost half of the gain, debt paydown and cash about 40%, and the multiple expansion from 6.0x to 7.0x the rest. A buyer of a larger, professionally managed company paying a higher multiple is a plausible but not guaranteed outcome; Exercise C tests what happens without it. ### Step 6: sensitivity (investor IRR including the search period, and searcher proceeds in USD m) | Growth a year \ exit multiple | 5.0x | 6.0x | 7.0x | 8.0x | |---|---|---|---|---| | 0% | 5.2%, 0.39 | 9.2%, 0.81 | 12.7%, 1.22 | 15.8%, 1.64 | | 6% | 13.7%, 1.35 | 17.6%, 1.91 | 21.0%, 2.46 | 24.1%, 3.02 | | 12% | 21.4%, 2.52 | 25.0%, 3.55 | 26.9%, 5.99 | 29.9%, 7.09 | Read the table as the searcher should. Below the hurdle the searcher earns only tranches 1 and 2, so her proceeds fall from 5.99 to 3.55 when the exit multiple drops one turn at 12% growth: the performance tranche makes her outcome more sensitive to results than the investors' is. With no growth the investors still get their capital back with a small return because the debt is repaid; the searcher's equity is worth little. ## Worked example B (half solved): a slower growth path Same deal as Worked example A, but revenue grows 10% a year instead of 12%. Exit at 7.0x after five years. | Item | Computation | Result | |---|---|---| | Year 5 EBITDA | `=2.5*1.1^5` | [ ] | | Exit enterprise value | 7.0 x [EBITDA] | 28.18 | | Cash at exit | from the model | 1.74 | | Equity at exit | 28.18 - 1.50 + 1.74 | [ ] | | Common equity Q | [equity] - 7.74 | [ ] | | Tranches 1 and 2 | [Q] x 25% x 2/3 | [ ] | | Hurdle value V_h | same as Worked example A | 23.73 | | Investors before tranche 3 | [equity] - [tranches 1 and 2] | 24.97 | | Tranche 3 | `=MIN(Q*0.25/3,MAX(0,24.97-23.73))` | [ ] | | Investor proceeds and IRR including the search period | | [ ] | | Searcher proceeds | | [ ] | Questions to answer: why does the investor IRR land exactly on 25.0%? What does the cap on the third tranche do to the searcher's incentive when results are near the hurdle? [ ] ## Exercise C (unsolved): maximum price and a downside C1. Keep the base case of Worked example A (12% growth, exit at 7.0x, debt fixed at 3.0x senior and 1.50 seller note). Investors require a 30% IRR including the search period. What is the maximum entry multiple, the enterprise value and the new equity at that price? Excel hint: Goal Seek the investor IRR cell to 30% by changing the entry multiple. C2. Downside: EBITDA stays at 2.50 for five years and the exit multiple is 5.0x. Find the senior debt left at exit, the equity at exit, the searcher's proceeds, the investor proceeds and the investor IRR including the search period. C3. In one paragraph, explain to a prospective searcher why her expected wealth from a search is much lower than the 5.99 of Worked example A, using the acquisition rate in "Search economics as of October 2026" and the downside of C2. ## Connections to other cards | Card or template | Connection | |---|---| | mba/mba-paper-lbo, mba/mba-lbo-model-card | The buyout mechanics this card assumes: sources and uses, sweep, returns | | mba/mba-entrepreneurship-guide | ETA as one of the paths of the entrepreneurship course | | mba/mba-opportunity-assessment-card | How to judge a market and a business model, applied to an acquisition target | | mba/mba-new-venture-launch-plan | The alternative path: building a company from an idea | | mba/mba-pe-value-creation-card | Building the value creation plan the board will hold the searcher to | | mba/mba-deal-structuring-card | Seller notes, earn-outs and rollover equity | | mba/mba-negotiation-planner | Preparing the LOI negotiation with a founder | | mba/mba-venture-finance-cap-table-card, mba/mba-term-sheet-card | How preferred and common securities share value in a venture setting | | mba/mba-corporate-governance-card | The board that supports and monitors a first-time chief executive | | finance/quality-of-earnings-scope, finance/due-diligence-request-list | Diligence before closing | | finance/credit-memo | The lender's view of the same deal | ## Common mistakes and misconceptions 1. **Quoting the aggregate IRR as an expected return.** The pooled figure is driven by a few outliers; many searches do not acquire and some acquisitions lose money. 2. **Forgetting the search period in the investor IRR.** Search capital is invested about two years before the acquisition; leaving it out overstates the investors' return by about three points in Worked example A. 3. **Treating the step-up as free money.** It shifts value from the gap investors and, through a larger preferred, slightly from the searcher to the search investors. 4. **Assuming the searcher's 25% is earned at closing.** Only the first tranche is; the second needs years of service and the third depends on investor returns. 5. **Paying for the multiple expansion at entry.** If the base case clears the hurdle only with a higher exit multiple, the deal depends on a judgement you cannot control. 6. **Ignoring customer concentration and founder dependence** because the margins look good. 7. **Over-levering a small company.** A first-time chief executive makes mistakes; debt service must survive them. 8. **Skipping quality of earnings** on a company whose accounts were prepared for tax, not for a buyer. 9. **Treating the seller note as equity.** It is debt, usually with interest and a maturity, even when subordinated. 10. **Running out of search time with no plan.** Set funnel targets and a deadline for each stage at the start. 11. **Confusing a self-funded search with a traditional one.** In a self-funded search the searcher pays for the search and keeps more equity but carries the risk and often uses government-guaranteed debt with different rules. ## Self-test questions 1. What does the step-up compensate search investors for, and who pays for it? 2. In Worked example A, what is the face value of the investors' preferred and why is it larger than the new equity? 3. List the searcher's three tranches and what each depends on. 4. Why does the gap investor earn a higher IRR than the search investors in Worked example A? 5. Compute the hurdle value at a 25% IRR for search capital of 0.56 two years before an acquisition with new equity of 6.90 and a five-year hold. Give the Excel formula. 6. Which screening criteria are the hardest to fix after closing, and why? 7. If the search had taken one year instead of two, what would the investors' IRR have been in Worked example A? 8. Why is the searcher's outcome more sensitive to the exit multiple than the investors' outcome? 9. Using the stylised formula, what is the value of a search unit with p = 58%, u = 1.5 and M = 3.72x? Why is this number misleading? 10. What fraction of the equity gain in Worked example A comes from multiple expansion? ## My notes and next steps | Date | Activity or deal | Numbers (contacts, LOIs, model results) | What I learned | Next step | |---|---|---|---|---| | *Example:* YYYY-MM-DD | Rebuilt Worked example A from blank | Investor IRR 26.9% | Forgot the search period at first | Build C1 with Goal Seek | | [YYYY-MM-DD] | [ ] | [ ] | [ ] | [ ] | ## Sources and further reading Primary works: - Jensen, M. C. (1986). Agency costs of free cash flow, corporate finance, and takeovers. *American Economic Review*, 76(2), 323-329. - Kaplan, S. N. and Stromberg, P. (2009). Leveraged buyouts and private equity. *Journal of Economic Perspectives*, 23(1), 121-146. Study series for dated facts (official page refused automated access on 2026-10-30; figures checked through secondary summaries, see "Search economics as of October 2026"): - Stanford Graduate School of Business (2026). *2026 Search Fund Study: Selected Observations*, case E967, data to 31 December 2025, https://www.gsb.stanford.edu/faculty-research/case-studies/2026-search-fund-study-selected-observations. - Stanford Graduate School of Business, Insights (13 July 2026). Search funds keep offering a proven path to ownership, https://www.gsb.stanford.edu/insights/search-funds-keep-offering-proven-path-ownership. Books (further reading, by name only): Ruback and Yudkoff, *HBR Guide to Buying a Small Business*; Rosenbaum and Pearl, *Investment Banking: Valuation, LBOs, M&A, and IPOs*. ## Answer key Worked example B: year 5 EBITDA 4.03; equity at exit 28.42; common equity 20.68; tranches 1 and 2 3.45; tranche 3 1.25 of a possible 1.72 (`=MIN(1.72,MAX(0,24.97-23.73))`); investor proceeds 23.73, IRR 25.0% including the search period (28.0% on acquisition equity only); searcher proceeds 4.69. The investor IRR lands exactly on 25.0% because the cap gives the searcher only the part of the third tranche that keeps investors at the hurdle. Near the hurdle, every extra dollar of exit value goes to the searcher until the full tranche is earned, which gives a strong incentive to push results over the line, and also an incentive to manage the timing and the reported numbers, which the board must watch. Exercise C: - C1: maximum entry multiple 5.62x, enterprise value 14.05, new equity 5.91, for an investor IRR of exactly 30.0% including the search period. - C2: senior debt left at exit 1.23; equity at exit 10.07 (`=5*2.5-1.23-1.5+0.3`); common equity 2.33; searcher proceeds 0.39 (tranches 1 and 2 only, tranche 3 is zero); investor proceeds 9.68, multiple 1.30x on all cash, IRR 5.2% including the search period. The debt is repaid and investors recover their money with a small return; the searcher has spent seven years for 0.39. - C3: the searcher's expected wealth must multiply the chance of acquiring (reported at nearly 60%, lower in recent cohorts) by a distribution of outcomes that includes cases like C2, where the equity is worth little, and cases like Worked example A. Years of salary below market during the search and the operating years are part of the cost. Self-test: 1. For funding a search that may not produce an acquisition and for the time their money is tied up; the gap investors pay most of it through a smaller share of the preferred, and the searcher a little through a larger preferred ahead of common. 2. 7.74: the new equity of 6.90 plus the credited search capital of 0.84 (0.56 x 1.5). 3. Tranche 1 at the acquisition; tranche 2 vesting over years of service; tranche 3 earned if investors reach the hurdle IRR, capped in this card at the hurdle. 4. Its money is invested two years later and avoids the search risk, while the step-up only partly compensates the search investors for the extra time. 5. 23.73: `=0.56*1.25^7+6.9*1.25^5`. 6. Customer concentration (SC-04) and the reason for sale (SC-05): neither can be negotiated away after closing. 7. 27.5%: `=IRR({-0.56,-6.9,0,0,0,0,25.7})`. 8. Because the performance tranche is earned only above the hurdle, the searcher's proceeds fall faster than the investors' when exit value drops near the hurdle. 9. 3.24x (`=0.58*1.5*3.72`). It ignores timing, the fees and salaries spent on the search, and the skew: M is not a single number but a wide distribution. 10. 17.8% (`=4.41/24.78`). ## Revision history | Version | Date | Author | Change summary | |---|---|---|---| | 0.1 | YYYY-MM-DD | [Your name] | First build of Worked example A from the inputs | | 0.2 | YYYY-MM-DD | [Your name] | *Example:* Rechecked the study figures and added an accruing preferred variant | ## Standard and licence note Based on standard search fund and leveraged buyout practice, the primary works listed above and the Stanford Graduate School of Business search fund study series, with dated market statistics reported through the secondary routes named in the sources and checked on 2026-10-30. The text, the model, the numbers and the exercises are original; no study text, case, term sheet or textbook is copied or paraphrased, and Dana Okafor, Brenholt Field Services and every number in this card are fictional. The template is independent and not affiliated with or endorsed by Stanford University, any search fund investor, lender or business school. Check the current study, term sheets and legal rules before you rely on them. Template licence: MIT.