9 Reasons Search Funds Fail

Search funds do not always provide great returns for investors. There are certainly many reasons as to why a search fund might fail, but a study conducted by author Benjamin Kessler and Professor Jim Ellis of Stanford Business School has worked to identify the most common reasons search funds fail. The hope of the study is for searchers to learn to avoid these areas of concern when searching for their potential business. 

1. Low or Negative Industry Growth – Low industry growth is defined as growth of 5% or less at the time of the acquisition. This study showed 72.7% of failed search funds were in declining or stagnant industries.
2. Complex Operations – Searchers who acquire businesses with operations they do not fully understand, or their management teams do not fully understand due to complex industries, ultimately reduces the firm’s competitive advantage and are a contributing reason for search funds failing 63.3% of the time.
3. Disagreement Between CEO and Board of Directors – Issues with communication or disagreements between direction of the firm between a searcher and his investors/board of directors assist in the failure of a firm 59.1% of the time.
4. Poor Gross Margins – 45.5% of search funds that fail have gross margins below industry average or a median of 20%, which typically is related to problems with differentiating your firm’s products or services from competitors in the area.
5. Failure in Execution – Searchers who fail name not fully understanding and executing the daily operations of the acquired firm as the reason for failure 45.5% of the time. Failure in execution is often correlated with acquiring a company with complex operations.
6. Customer Concentration – 40.9% of failed search funds are due to high customer concentration, or having one or a few key customers that account for over 25% of a business’ revenue. 
7. Restrictive Capital Structure – Companies that use too much seller or institutional debt have free cash flow issues because of larger interest and principal payments, rather than using cash flow to expand business operations. This leads to acquisition failure 40.9% of the time.
8. Conflict With Previous Owner – Previous owners who cause disruptions with the searcher or board of directors regarding the new direction of the acquired firm accounts for 36.4% of reasons for failure.
9. Problems Hiring or Retaining Sufficient Talent – 31.8% of firm’s failure is due to not being able to retain or hire middle management after acquisition or when firm is looking to expand.