'Mini private equity' is exploding, but there are risks. The biggest dos and don'ts, according to experts

• Search funds are having a moment, but that doesn't mean they're right for everyone.
• Half of all search funds fail, so it's important to be sober and clear-minded when jumping in.
• We list the dos and don'ts of success in the world of entrepreneurship through acquisition.

Judd Lorson became interested in search funds as a pathway to entrepreneurship while at the Yale School of Management and launched a fund shortly after he got his MBA.

Even with the help of Search Fund Accelerator, which provided capital and mentorship, the road to buying a company turned out to be "messy and chaotic," Lorson said. In a research paper about his experience, coauthored by Yale School of Management senior lecturer A.J. Wasserstein, the former Navy officer described how he and his wife would search Zillow for homes when he was close to a deal, only to see their dreams evaporate when the acquisition fell apart and they had to start over again.

Even after buying a business, the challenges continued, with Lorson once having to forgo pay for two weeks while waiting for a short-term loan from his investors to pay expenses.

Search funds, sometimes referred to as "mini private equity," are having a moment. A 2024 Stanford Business School study found that the creation of such funds, which raise money to buy an existing small business, hit an all-time high in 2023 (the latest year studied) with more than 90 first-time search funds raised. Stanford found that the strategy is particularly popular among young people with nearly 80% of first-time fundraisers in 2023 clocking in at 35 or younger, including many freshly graduated MBAs.

For every story of someone becoming their own boss and making millions, however, there's a story of a failed business or someone who never even buys one. Lorson wrote that he hoped his own challenges would help others see the "realities of this career path" before making the plunge.

In an effort to help aspiring searchers, Business Insider spoke to search fund researchers and entrepreneurs about what they should know to make a clear and sober decision about their future.

"Many entrepreneurs fantasize about a $10 million payday," said Wasserstein. And while this can happen, it's rare. Wasserstein's examination of the 2022 Stanford Search Fund Study found that only 16% of search fund entrepreneurs delivered a $10 million-plus payday, with an average payday for those who managed to sell their business at $5.7 million.

"It is rare and not easy in any way," Wasserstein said of the big payday. "Understand what needs to happen for that to be a reality."

Don't plan a vacation anytime soon

Being the boss means you're never really off the clock. This can create challenges in your personal life and prevent you from taking a vacation — or even a weekend off.

Chad Howard, who left his corporate job to start a portable toilet rental business last year, has dealt with this firsthand. Howard was visiting family out of state when one of his largest clients called to say that they had an emergency and needed 10 portable toilets delivered as soon as possible to a location that had just run out of water. He would have just delivered the toilets himself, but he wasn't nearby, and none of his usual workers were free.

"I just don't travel as much as I used to because that feeling when you have to coordinate everything by phone feels terrible," he told BI of the experience.

Howard said the pressure to be available is magnified by the desire to make a good impression as a new business owner.

"Work-life balance exists in corporate America because most things aren't an actual emergency," he said. "Someone might say that, but in reality, if something comes in at off hours, it can wait until the next day, and nothing bad will happen."

Howard said you have to be able to solve problems when you're in charge. Gone are the days when he could sleep in until 8:00 a.m. on the weekends or easily plan out when he could fit in a workout. It's more exciting, but it's much harder to have a "normal" day.

Don't expect to walk away when you sell

According to the Search Fund Primer, the typical search fund timeline involves two years of searching for a business, followed by five to six years of operations before exiting a company, usually through a sale. A study conducted by Wasserstein, however, suggests that an "exit" doesn't necessarily mean the commitment to the business is over.

Wasserstein found that more than three-quarters of sales were to private equity firms or companies backed by private equity. And the majority of entrepreneurs making these deals maintained stakes in their businesses.

"Our data says that 65% of exiting searchers roll 25% to 49% of their equity," Wasserstein said. "Additionally, they need to stay with the acquirer for approximately two years."

They often have to stick around as CEO under a private-equity boss, which can present a whole new set of challenges. Instead of answering only to their investors, searchers may also be beholden to their new owners. Wasserstein's study found that these new owners have a net promoter score of negative 33, which suggests that search funders who've sold are more likely to be unhappy with their new partners than not.

The pay is better, however, with the majority of those who stick around for more than five years with their new equity partners making more than 30% more than they did when they were running the business themselves.

Be prepared to give up

Half of search funds fail. According to the 2024 Stanford search fund study, 37% never find a business, while 19.5% fail to make a return on investment. Another 5% have actually lost all of their equity. Failure is part of the game in entrepreneurship, and the earlier you can deal with it, the better your career.

The inability to accept failure can be costly as it can lead searchers to stick by businesses that aren't working.

"Our data says that entrepreneurship through acquisition CEOs and investors hang on to floundering businesses for too long," Wasserstein said, adding that "bad companies tend not to recover."

His research categorizes search fund failures into three categories: no-dealers, imploders, and drifters.

No-dealers never find a company, which can be emotionally challenging but doesn't carry nearly as much risk of long-term negative impacts. Imploders fail soon after acquisition, which can be traumatic, but means that the searcher hasn't put too much of their career into it.

Drifters hold on because they're determined to improve their companies, but, as Wasserstein writes, "time is a vicious enemy."

"If a drifter runs a business for five to ten years in perpetual anticipation of breaking out the next year, time becomes fleeting," he wrote, adding, "If a searcher is a decade into a project at 45 years old with no equity to show for their efforts, they understandably feel frustrated and disappointed."

The longer an entrepreneur spends with a failing business, the worse the impact on their lifetime earnings and professional opportunities.

It can even lead to "emotional and physical wear," he said, and can have a major negative impact on their relationships.

"As the CEO relentlessly fights to improve the company, they often neglect their health, friends, and family," Wasserstein wrote. " More often than not, the CEO's spouse, closest friends, and family realize perseverance is futile before the CEO admits this to themself."

Find a peer group or mentor

There are many guidebooks, most notably the Stanford Search Fund Primer and the Harvard Business Review's Guide to Buying a Small Business, to help searchers navigate the process, and a range of online influencers and communities. But it's also important to find people you can call in a jam.

Finding and running a business is "far more demanding than it appears on paper," said Newton Campos, professor of entrepreneurship at IE University in Madrid and the founding partner of Newton Equity Partners, a recently launched fund that invests in search funds. You must be a capable fundraiser, negotiator, sales agent, and business operator. And because investors are often buying someone's "life's work" or "a piece of family history," it requires emotional intelligence alongside modeling skills.

If you're in graduate school, find a professor or alumnus you can lean on. People coming from the business world might want to find investors who have the time and ability to act as a guide or mentor, or work with an accelerator like Lorson did.

Finding support can also help emotionally. Searchers often move to new cities to start their businesses, which can leave them socially isolated and much too busy to make friends. Also, being the boss can be lonely, as Josh Leslie, a CEO, told BI back in 2019.

"I don't get to go to lunch and complain about the boss with my coworkers," he said. "My role in the company is unique and uniquely isolating."