Why self-funded search entrepreneurs raise capital

One approach gaining traction in the SMB acquisition world is the self-funded search: entrepreneurs using their own capital—and personally guaranteed SBA debt—to search for and acquire a business. But sometimes, they need a capital injection to close a deal, which is when they choose to raise capital from investors. Self-funded search entrepreneurs are typically former or current operators searching for businesses without an investor-backed salary. They often approach the purchase of a business as a lifelong endeavor—in contrast to some traditional funded searchers. 

We explain the difference between these search models, the key qualities of self-funded search entrepreneurs, and why self-funded searchers choose to raise capital.

Differences between self-funded searching and traditional search funds

Back in the 1980s, Stanford researcher H. Irving Grousbeck created the concept of a search fund to spur more entrepreneurship in the university’s MBA program. At its core, a search fund is an investment vehicle designed to deliver capital to an entrepreneur so they can search for, acquire, and operate a business. Traditional search funding usually results in searchers owning a minority portion of the business and having a bit less control over the search process overall. But because the searcher is backed, their personal costs and risk are mitigated by investors.

However, that isn’t the only funding option search entrepreneurs have. In contrast to traditional search funding, self-funded searchers are entrepreneurs who search for a business to buy without investor backing. In contrast to traditional search funding, self-funded searchers may use investor capital to fund the acquisition of a business after an LOI is signed—not for back-paying themselves for the search, for example. They are also commonly backed by personally guaranteed SBA debt (specifically the SBA7(a) loan), significantly raising their personal risk. 

Why self-funded search entrepreneurs raise capital

After funding themselves for months while searching for a key acquisition opportunity, many self-funded search entrepreneurs don’t have the capital to purchase a business when the time arises. Though they may carry SBA debt, they often need additional capital to shoulder the business purchase, especially considering they are paying transaction fees out-of-pocket. 

Oftentimes, these self-funded searchers are veteran business owners or corporate refugees that have substantial acumen operating profitable enterprises. This is in contrast to traditional search fund search entrepreneurs who may have the capital to fund an acquisition, but lack the business expertise honed through years of practice required to operate and grow an existing enterprise. 

In some cases, this capital injection is used to buy businesses that are out of reach of self-funded searchers in the first place. With help from outside funds at closing, self-funded searchers can reach businesses with EBITDA ranges normally outside of their personal investment range. 

Key qualities of self-funded search entrepreneurs

Self-funded searchers and their acquisition opportunities often have vastly different characteristics from those of traditional search funds. 

Here are two key differentiators that set self-funded searchers apart from traditional search fund entrepreneurs.

Former or current operators

“What's taught in the classroom, versus what the reality of running a business is, are two completely different things, in my opinion,” says Ryan Sims, a former investment banker and self-funded search entrepreneur. Sims currently operates two businesses out of Florida: one franchise business and another independently owned.

Like Sims, many self-funded searchers are former or current operators who are ideally situated to acquire a business regardless of whether they have the capital themselves. They know more than just the numbers but understand the inner workings of an operation aside from its balance sheet.

In Sims’ experience, SBA lenders are looking more and more at the background of business owners when lending as well. Sims noted that SBA lenders prefer to see hands-on experience with business building and operating, trying to answer questions such as “Why are you qualified to do this on the ground level and operate this business?” as more important than “What is your credit score?” Though FICO scores, collateral, capital, and business income generation potential all form part of the underwriting process, experience shouldn’t be understated.

Heavily vested in the business

Unlike traditional search fund entrepreneurs, self-funded searchers don’t use investor capital to pay themselves a salary as they search for a solid acquisition. Instead, they rely on planning their runway properly and proper planning before starting their search.

As a result, self-funded searchers seeking capital at the acquisition stage are heavily invested in the business they want to purchase—both financially and emotionally. These searchers are stepping into these businesses to be full-time operators. Often this business becomes their livelihood for years, rather than a quick buy-and-sell strategy. They want their purchased business to thrive. After all, it’s the result of months of searching on their own dime. 

In addition, self-funded searchers often carry large amounts of personally guaranteed SBA debt. Some take up to 70% to 80% of enterprise value debt from SBA lenders. If their business fails, they carry the responsibility and liability for the debt instead of institutions. 

Unlike traditional search methods, self-funded searchers typically end up with a majority of a business’s common equity after the deal is completed. These owners have more internal motivation to see their business succeed, which also translates to investor outcomes. 

Why investing in self-funded searchers is key to building strong communities

This approach taken by self-funded searchers helps build more economic scaffolding for growth in their local communities, which can have a ripple effect in multiple industries. Investors that back local deals at the end of a rigorous search can know they are supporting a business that wants deep, community roots that benefit the ecosystem around it. 

Self-funded entrepreneurs routinely employ people in their communities, adding economic growth for families and the community as a whole. There’s also the aspect of familiarity—new owners who own a majority interest in the community business become friendly neighbor owners.

On top of stimulating local economies, small businesses are well-known for their charitable work in communities. Research from the non-profit organization SCORE found that small businesses “donate 250% more than larger businesses to local non-profits and community causes,” its report states.

Investors that back deals of self-funded searchers can support local communities in powerful ways, both economically and charitably.

Bottom line

Self-funded searchers present an appealing opportunity to investors: have their money in the hands of someone who has operating experience and a high incentive to create a flourishing business.

Interested in seeing what opportunities exist? Explore our investment opportunities today through our Mainshares’ investor platform.

Information posted on this page is not intended to be, and should not be construed as tax, legal, investment or accounting advice. You should consult your own tax, legal, investment and accounting advisors before engaging in any transaction.