Search funds and impact

A VC firm known as Sleeping Giant Capital Principled Impact Fund recently launched a $50m fund to “offer opportunity to a new generation of business executives while keeping established businesses local.” Though the search fund model isn’t explicitly mentioned in the press release, it seems the fund is at least borrowing key concepts from the search fund model.

This is not the first time someone has explored the marriage of impact investing and the search fund model.

In the past two years alone, I have heard pitches for the following:

1. An accelerator of search funds that places first-generation minority immigrants at the head of very small American businesses.

2. A fund of search funds with an impact objective in Africa.

3. A more traditional search fund, but with an exclusive focus on businesses with ESG at the core in Australia.

4. Traditional search funds with a less well-defined desire to “make an impact.”

There’s no denying that impact investing is on the rise, and for good reason. The question is whether it can marry well with the search fund model, and if so, what impact can realistically be achieved, if any?

Those who hesitate to apply an impact lens to search fund investing do so likely because they see it as an additional obstacle in an already-difficult model. In the world of traditional search funds, about ⅓ of searchers fail to acquire after a 2-year nationwide search, and about ⅓ of those who do acquire fail to return full investor capital. Better odds than early-stage investing for sure, and when investing in a portfolio the returns are outstanding. But it’s still hard.

The difficulty of this journey is something I routinely impress upon aspiring searchers as well. A win is not guaranteed, regardless of skill and effort. Chance and circumstance play a material part in the story as well.

For that reason, investors are wary, and searchers likely should be wary, of applying any filters to the search that could further reduce the searcher’s probability of success. For example, searchers with a narrow geographic focus often find it difficult to raise capital, because investors believe it reduces the pool of candidates, reduces the searcher’s ability to capitalize on any industry insights due to the lack of depth in each industry, and therefore negatively impacts the searcher’s overall probability of a win.

Does an impact lens reduce a searcher’s probability of success? That depends on how impact and success are defined. Fundamentally, if the searcher is applying a filter to opportunities that narrows the pool of targets and value creation strategies, and success is defined purely in terms of financial returns, then it would be logical to infer that the success rate of an impact search fund would be less than that of a traditional search fund, which is unbound by such restrictions.

However, we may arrive at a different conclusion in two ways:

1. We redefine success to include KPIs beyond financial returns to investors, or

2. We see something inherent to the search fund model that fits with the impact investing thesis.

We see a hint of option 2 in Sleeping Giant’s approach, which aims to keep businesses local by pairing local entrepreneurs with local capital in an effort to acquire those businesses. While I don’t know whether Sleeping Giant is actively invoking search fund principles in this approach, there seems to be significant overlap. Of course, their model applies that narrow geographic focus discussed above, which could potentially impact financial returns relative to the traditional search fund approach.

But is there something inherent to the traditional search fund model, without geographic constraints, that fits the impact thesis? I think there just might be.

When I speak with lenders, advisors, government officials, and business owners in Asia Pacific, there is real concern, or even fear, in their voices when they talk about the future for SMEs, many of which are currently run by retirement-age founder-owners without succession plans. Banks in Australia tell me that every other conversation they have with SME clients is about succession planning. When I asked a Singapore official why the government isn’t talking about the SME succession problem, instead focusing heavily on startups, he responded that they are talking about it - just not in public, because they don’t have a solution yet.

At the risk of sounding melodramatic, an entire generation of small businesses faces potential extinction if this succession issue is not addressed head-on. And the search fund model just might hold the key to make a dent in this problem. Would such a dent qualify as impact?

Though the search fund model is quickly growing in popularity, it is still a very niche industry, accounting for only about 30-40 acquisitions per year and amounting to less than a blip on the radar when it comes to addressing the succession crisis. The model in its current form is not built to handle thousands of deals per year, and it is therefore not ready to make large-scale impact. However, with the right modifications, right partnerships, right funding, and right support, could it provide some clues as to how we might ensure the survival of a generation of small businesses? Could this be the impact that search funds can inherently make - catching a generation of businesses before they perish, and placing them in the hands of a new generation of caretakers?