How to structure a search fund

Structuring a search fund transaction involves several key steps and considerations to ensure a successful acquisition and alignment of interests between the searcher and investors.

Thought and consideration at this early stage will help to save time, money and potential difficulties further down the road.

Fund Formation

Applies to both traditional and self-funded searchers

The first step is to establish the search fund entity, typically structured as a limited company or limited liability partnership.

When choosing between a limited liability partnership and a private limited company for a UK search fund acquisition vehicle, the decision largely hinges on tax treatment and investor expectations. A limited liability partnership offers tax transparency, allowing profits to flow directly to partners without corporation tax, and provides flexibility in allocating returns among investors. This can suit bespoke arrangements but comes with drawbacks such as self-employment tax exposure and the absence of a share structure, making it harder to issue equity classes or options for incentivising employees.

Conversely, a Ltd company is the more familiar and investor-friendly option, supporting multiple share classes and dividend-based tax planning. It also offers potential exit advantages through the Substantial Shareholdings Exemption and Entrepreneurs’ Relief. However, it introduces double taxation (profits taxed at the company level and again on dividends) and requires more compliance under the Companies Act.

During formation, the searcher should also define the fund’s investment strategy, including its target industries, geographic focus, and key investment criteria. These decisions are critical for attracting capital and maximising returns.

Capitalisation

Traditional Search

Searchers raise initial capital from external investors to fund the search phase, including a modest salary and administrative costs. This funding is typically expected to cover a 2-year window. In traditional search funds, securing sufficient investor contributions is critical to ensure the searcher can focus on finding the right acquisition opportunity while meeting operational needs.

Self-Funded Search

Searchers fund the search phase themselves, using personal savings, therefore, there is no outside capital raised until a deal is identified. Since self-funded searchers don’t rely on external investors during the search phase, they have greater flexibility but must carefully manage their capital to ensure sustainability during the search phase.

Investor Agreement

Traditional Search

A formal Investor Agreement is drawn up at the time of raising capital. This includes terms on management fees, carried interest, equity splits, and governance rights. Legal counsel usually drafts the agreement, based on commercial terms proposed by the searcher and negotiated with lead investors.

We highly recommend engaging a lawyer with prior experience in these agreements to draft or review the agreement. A lawyer familiar with common investor expectations and standard terms will help ensure that the agreement protects your interests, avoids future disputes, and meets market standards. They can also assist in clearly communicating complex terms to all parties.

Self-Funded Search

There is no investor agreement at this stage. Any investment agreements are made at the point of acquisition, when equity or debt financing is needed to close the deal.

Deal Sourcing

Applies to both traditional and self-funded searchers

Develop and implement a strategy to source potential acquisition targets. Traditional searchers often adopt a full-time, structured approach supported by investor capital, using a mix of cold outreach, broker relationships, and support from interns (often current MBA students with an interest in Entrepreneurship Through Acquisition). A range of data platforms are utilised to identify a list of potential targets including, Pitchbook, Beauhurst, MarketIQ and MarktoMarket. Self-funded searchers typically rely on a more focused, relationship-driven strategy within familiar sectors. In both cases, consistent and disciplined sourcing is key to identifying strong acquisition targets.

Traditional searchers may be expected to report progress to investors while self-funded searchers have more flexibility in pace and accountability.

At this stage, it is also common to set up a simple website for your fund. This typically sets out the target acquisition criteria.

Letter of Intent/ Heads of Terms

Applies to both traditional and self-funded searchers

Once a target has been identified, the buyer and seller agree on key terms that outline the basis of the offer. These terms typically set out the proposed deal structure, headline price, and the intended approach to potential areas of negotiation or ambiguity.

If the offer is based on an EBITDA multiple, this must be clearly specified to avoid disputes later. Particularly if the target’s actual EBITDA is lower than initially expected. The document will also include an exclusivity period (commonly around three months), which formalises the verbal agreement reached and prevents the seller from considering alternative offers during this time.

A significant challenge for any searcher is demonstrating to the seller their ability to complete the transaction, both in terms of competence and financial backing, before exclusivity is granted. Traditional searchers often address this by referencing their committed search capital and investor base as proof of capability. Self-funded searchers, on the other hand, can establish credibility by obtaining soft commitment letters from potential investors or lenders to show they have access to the necessary funding.

Due Diligence

Applies to both traditional and self-funded searchers

Once exclusivity has been agreed thorough due diligence must be conducted to validate assumptions and uncover risks that could lead to renegotiation or even termination of the deal. This process is typically mandated by investors and lenders to ensure the acquisition is sound. The types of due diligence conducted are:

• Financial: Focuses on the accuracy of historical accounts and calculate quality of earnings and working capital requirements. The objective is to confirm the reported performance reflects the underlying reality and to identify any adjustments needed for the valuation of the Target.
• Tax: Examines compliance with UK tax laws, potential liabilities, VAT treatment, and any risks related to historic filings or group structures.
• Legal: Reviews corporate structure, ownership, contracts, employment agreements, intellectual property, and any pending litigation. This ensures the target has clear title to assets and no hidden legal exposures.
• Commercial: Evaluates the market position, competitive landscape, customer concentration, and growth prospects of the Target. It is often supplemented by operational reviews of systems and processes.

Financing

Traditional Search

The searcher raises acquisition capital typically from the original investor group, often supplemented with bank or private debt. Utilising these traditional financial instruments a typical traditional searcher can earn up to 25% of the common equity in a solo search or 30% in a partnership, split equally between the partners. These rights, known as “carry,” vest in three tranches. The first third is vests upon acquisition of the target company, giving searchers immediate ownership once the deal closes. The second tranche is tied to continued management of the business over four to five years, vesting gradually through monthly, quarterly, or annual periods, with accelerated vesting possible if the company is sold early.

The final tranche is performance-based and linked to investor returns. If the internal rate of return (IRR) is below 20%, searchers receive nothing from this tranche. Between 20% and 35%, vesting occurs on a sliding scale, with partial entitlement based on performance, for example, half the tranche at a 27.5% IRR. At 35% or higher, searchers receive the full third. However, differing vesting structures are becoming more prevalent in recent years.

Self-Funded Search

The searcher sources financing at the time of acquisition, often through a mix of personal capital, investor equity, and debt. Investors are approached with a live deal rather than upfront. Self-funded searchers will typically take a majority stake of the company they acquire.

Regardless of approach, it is essential for both traditional and self-funded searchers to structure their financing to balance leverage and flexibility, while ensuring alignment of interests with investors. In most cases, both models employ the maximum prudent level of debt financing, with equity, vendor loan notes, or earnouts used to bridge any remaining funding gap.

Transaction Execution

Applies to both traditional and self-funded searchers

Once the buyer has completed the majority of their due diligence, the process of formalising the transaction terms begins. The buyer’s lawyers typically draft the initial Sale and Purchase Agreement (SPA), reflecting the commercial terms agreed in the Letter of Intent, including the purchase price and key deal structure. Findings from the due diligence process are also incorporated at this stage.

The draft SPA is then reviewed and negotiated with the seller’s legal team. Common areas of negotiation include the scope and duration of warranties, limitations on liability, and post-completion obligations.

When both parties reach agreement on the final terms, the SPA is executed alongside any necessary ancillary documents, such as disclosure letters, board resolutions, and shareholder approvals. Completion takes place once all conditions are satisfied, funds have been transferred, and legal ownership of the shares is formally transferred to the buyer.

Post-Acquisition Management

Applies to both traditional and self-funded searchers

Once the acquisition process has been completed, the real work begins. The buyer must implement a clear plan for managing and growing the acquired business post-acquisition. This typically starts with a structured transition period, including onboarding key staff, integrating systems, and establishing governance and reporting frameworks. Early engagement with the management team is crucial to build trust and ensure alignment on strategic goals.

From there, the buyer should develop and execute strategic initiatives, operational improvements, and growth strategies aimed at maximising value creation and achieving the investment objectives.

Investor Communication

Traditional Search

Following an acquisition, traditional search funds maintain structured reporting and regular investor communication as a core part of their operations. Investors who have committed capital typically expect periodic financial reports, strategic updates, and operational insights that demonstrate progress against the agreed value creation plan and overall business performance.

Self-Funded Search

In contrast, self-funded searchers generally have fewer formal reporting obligations after acquisition. Particularly where the transaction has been financed primarily through personal capital or debt. Investor communication in these cases is typically ad hoc and governed by the specific terms agreed with any external equity partners involved in the deal.

Exit Strategy/Long Term Hold

Applies to both traditional and self-funded searchers

Searchers should establish a clear and well-defined exit strategy, evaluating potential options such as a sale to strategic acquirers, private equity firms, or, in some cases, an initial public offering (IPO). Investors typically seek a return on their investment within 5 to 7 years, making forward planning essential from the outset.

For searchers pursuing a long-term hold strategy, it is important to outline how original investors will be repaid. One common approach is debt refinancing, where the company raises new debt based on its improved performance and uses the proceeds to buy out investors. This structure enables the searcher to maintain control of the business while providing liquidity to backers.

Conclusion

By following these steps and key considerations, search fund operators can structure transactions that align with investor objectives, mitigate risks, and maximise value creation for all stakeholders. Engaging experienced legal, financial, and strategic advisers throughout the process further enhances the likelihood of a smooth, efficient, and successful transaction.