How red is the flag on a very young target company?

You see it: a two-year-old company that ticks several appealing boxes – recurring revenue, looks like low capital intensity, maybe even hitting decent EBITDA numbers already. It feels shiny, new, exciting. The little voice whispers, “Could this be the one?”

Before you get swept away, let’s pause, because chasing these toddler-aged businesses, tempting as they might seem, often runs smack into the brick wall of what a search fund is fundamentally designed to do. It touches the very core of why this model even exists.

Remember Why You're Here: De-Risking the Dream

Let’s rewind. Why did you choose the search fund path? For most of us, it wasn’t about wild, speculative bets. It was about finding a smarter, less risky way to step into a CEO role and run our own show. The whole model is built around de-risking an inherently tricky venture: buying and leading an SME.

Think about the built-in challenges we’re already juggling:

• We’re buying SMEs, which naturally carry more risk than big, established corporations.

• We’re often installing a first-time CEO (that’s you!) who, despite being sharp and driven, probably lacks deep time-in-grade in that specific industry.

• We usually use leverage (debt) to buy the business, which juices returns but also magnifies any mistakes or downturns.

• The return expectations are high (think 30%+ IRR), demanding real value creation, not just coasting.

Given all that, the smart play is to aggressively mitigate risk wherever possible. We’re not VCs throwing darts. We need stability. We need predictability. The Stanford Study hammers this home; even with careful selection, a chunk of deals go sideways (around 31% resulted in partial or total investor loss in the 2024 study).

How do we fight that? We hunt for businesses that demonstrate "enduring profitability." These are companies that have proven they can make money, reliably, year after year. They've shown they can handle bumps in the road, economic swings, maybe even losing a big customer without collapsing. They usually have stable revenues, decent margins, and enough scale to absorb shocks. Crucially, they often have a management layer that can keep things running smoothly during the transition.

Getting that kind of proof takes time. Years. Often decades. That’s why you see searchers targeting companies that are 15, 20, 30 years old. They’ve weathered storms. They’ve proven their resilience. That history is what gives investors the confidence to back a newer CEO and add debt to the equation.

So, What's Wrong with a Two-Year-Old?

When you look at the question through that de-risking lens, the problems with a super young target company become glaringly obvious.

The Track Record Problem

This is the big one. Two years just isn't enough time to prove much of anything. Has the business model really shown resilience? Or did it just launch during a boom time? Did it ride a temporary trend? Was early success down to one lucky contract or the founder’s unique charisma? You simply don't know. It hasn’t faced a real recession, survived major competitive attacks, or navigated serious operational hurdles. That history – that proof of "enduring profitability" – is missing.

The Hypergrowth Headache

There’s a weird paradox here. If a company did reach typical search fund size (say, $2M+ EBITDA) in just two years, it must have grown at lightning speed. Sounds great, right? Maybe not.

Managing hypergrowth is an operational nightmare. It burns cash, strains systems, and pushes people to their limits. Doing that successfully is tough even for seasoned operators. For an inexperienced CEO learning the ropes, managing investors, and servicing acquisition debt? It’s often a recipe for disaster. That kind of profile screams for a VC or growth equity structure (less debt, more equity), not a stable search fund LBO. Plus, can that growth even last? You risk buying at the absolute peak, based on momentum that might fizzle out.

It’s Probably Operationally Immature

Young companies rarely have that stable middle management layer you need for a smooth transition. They’re often heavily reliant on the founder(s). Customer concentration is usually higher – lose one big client, and you’re in deep trouble. Systems and processes? Often messy, undocumented, or just not built to scale. This makes reliable due diligence incredibly difficult. You’ve only got maybe one or two years of financials. Trying to build solid projections off that is guesswork compared to analyzing a business with a decade or more under its belt.

The Motivation Mismatch

Think about the typical search fund seller. Often someone nearing retirement has built the business over decades and wants to see their legacy protected, to take care of their people. They value the idea of a sharp, motivated searcher coming in to be a good steward. That’s often why they choose a searcher, even if they could squeeze out a few more dollars elsewhere.

Now, picture the likely seller of a two-year-old rocket ship. Probably younger. Probably less emotionally tied to the legacy or the employees. Often, their main goal is simple: cash out, maximize the price, maybe flip it quick. Those non-financial attributes that make a searcher appealing to a traditional seller? They likely mean very little.

This puts you, the searcher, at a huge disadvantage. You usually win deals on rapport, certainty of close, and the promise of stewardship – not by being the highest bidder. But when the seller only cares about the highest price, you’re bringing a relationship pitch to a price fight. Strategics can pay more because of synergies. Growth equity might have a model better suited for the risk. You’ll likely get outbid. Which leads to the dreaded...

Get Ready for the Investor Grilling (The 'Why Us?' Question)

Your investors signed up to back deals fitting that de-risked, enduringly profitable profile. Bring them a two-year-old target, and alarm bells will go off. Be prepared for tough questions:

• "How does this fit our model of buying stable cash flows? Where's the proof?"

• "Is this risk profile really appropriate for a search fund, especially with the debt we plan to use?"

• "Are we paying for proven performance, or just speculating on future growth?"

• "Why are we the winning bidder here? If it's so great, why didn't a strategic or growth fund pay more?" (That’s the 'winner's curse' question – did you win only because you overpaid or missed something others saw?)

Justifying a young target to experienced search fund investors is an uphill battle. The burden of proof is entirely on you, and it needs to be exceptionally strong.

How Red Is That Flag? Blindingly Bright.

So, back to the original question. How red is the flag on a two-year-old target company? It’s bright, flashing red. It deviates significantly from the ideal search profile – in its business maturity, its risk level, and likely the seller’s motivations.

Is it impossible to buy a young company through a search fund? No, few things are truly impossible. Maybe you find that one-in-a-million situation with unique mitigating factors – iron-clad contracts, incredibly mature operations for its age, a seller with very specific, non-financial motivations.

But these are rare exceptions. For most searchers, especially on your first deal, trying to make one of these work is choosing the path of most resistance. You’ll likely need more equity (less leverage), face brutal due diligence, and constantly battle uphill with investors.

The proven path to success in this model is focusing on mature, stable businesses that have demonstrated their staying power. Don’t let the shine of rapid growth distract you from the fundamental goal: acquiring a stable, profitable platform to begin your journey as CEO. Stick to the playbook – it works for a reason.

Sources:

2024 Search Fund Study: Selected Observations