How Private Equity works in the startup world

Management buy-out, LBO and Search Funds!

Ok, we are on the Private Equity side now. The difference between PE and VC is that PE invests more and takes a majority stake of the company. Also, they most likely change the management team. If this is the case, we would be talking about management buy-in. If we do not have a change of the management team, then we are talking about leveraged buyout or LBO. LBOs are performed both by PE firms as well as large organizations.

Another scenario, in which the management team buys the majority of the company’s assets, is called a management buyout or MBO. Usually the management does not have the capital to do such kind of transactions, so they go out and seek funding from Private Equity.

But, in the last 30 years there has been a new business model arising called a Search Fund.

Such a fund is usually created by recent business graduates who raise anywhere from 2 to 15M and then search, find, acquire and manage a small company before selling it again. Here’s how it goes:

The search fund managers usually raise from many different individuals who have experience and can provide mentorship and/or good connections. Thus, the average ticket size can be around 100k, and usually one individual can purchase a limited number of tickets. Usually the search fund managers have trouble raising enough money, so one great incentive they use to stimulate the LPs is the announcement of closing of the fund. After having raised sufficient capital to proceed, they go on and start searching for companies in the 5–30M price range, that are operating in a much segmented market, have sustainable market position as well as a track record of stable positive cash flow.

Sounds like a piece of work, right? Check out the faith of one of these search funds here.

Thanks for reading! In my next post, I am talking about the light in the tunnel — SELLING THE BUSINESS! Go ahead and check it out :)