Developed in the United States in the 1980s, search funds are beginning to gain recognition and traction in Brazil. As of October 2022,[1] 24 search funds were identified in the country. Of these, 12 have completed the Acquisition phase, and only one has reached the Exit stage (phases explained below). The outlook is that many more deals will take place in the coming years, particularly in light of a promising market for this investment model in Brazil.
To understand search funds, it is essential to know the key players involved: the searcher, an entrepreneur with a high risk appetite, eager to manage a company; the investors, individuals and companies with a high-risk investment profile and well-capitalized, who trust in the searcher's management abilities; and the target, a high-growth potential company that will be acquired with the investors' funds and, from then on, will be managed by the searcher.
In Brazil, searchers are typically young (between 27 and 35 years old) with an entrepreneurial spirit, a background in business administration or management – usually with an MBA, either in Brazil or abroad – and international work experience. It’s worth noting that searchers often do not have direct experience in company management. However, this 'inexperience' is compensated for by a more hands-on approach from the investors, particularly through the creation of an active and experienced board of directors after the Acquisition, made up of investors and/or qualified professionals from the market.
As many searchers have international background and work experience, foreign investors often make up part of the cap table. This is because these investors are already familiar with and practice this investment model in their own countries, recognizing the potential returns. However, our experience shows significant changes in the involvement of foreign investors in search funds in Brazil.
Until the end of 2022, most investors in search funds in Brazil were foreign, with a few Brazilians involved in the cap table. However, in our recent work advising several searchers, we have noticed a shift: Brazilian capital has taken the lead, although foreign investors still maintain a significant presence. In some cases, the cap table was made up entirely of Brazilian investors.
We believe the reason for this shift is primarily due to two factors. First, there has been a noticeable development among Brazilian investors in the search fund industry. Over time, we have seen the formation of significant institutional investors, who have gradually increased their participation in the cap tables with more capital and a more proactive approach in acquisition processes, supporting searchers during this challenging phase. Individual investors have also increased in number. Specifically, we have noticed that, in addition to the recognizable names who have been involved since the early days of the industry in Brazil, new players have emerged, interested in the model after discovering the potential returns.
The second factor contributing to this shift in the structure of the captables lies in economic conditions. Brazil has always been a risky environment for investments, which is why it has attracted foreign investors due to the high potential returns. However, more recently, Brazil’s economic landscape has become more challenging, requiring greater caution from foreign investors. Of course, this does not mean a halt to investments, but rather a more prudent approach in selecting the searcher and the investment thesis.
Nevertheless, the presence (and experience) of foreign investors makes the structure more complex. Sophisticated and cautious (especially in businesses involving Brazil), foreign investors demand strong corporate governance and stringent compliance rules. This is a key consideration for searchers and their legal advisors, especially in the Acquisition and Post-Acquisition phases (described below).
Now that we’ve outlined the searchers and investors, it’s important to discuss why they come together: the target. These are typically mid-sized, family-owned businesses with revenues between USD 4 million and USD 20 million, strong operational cash flow, solid market presence, and great growth potential. This last characteristic is evaluated by the searcher, considering various criteria such as industry growth potential, the possibility of market consolidation either organically or through acquisitions, and identifying inefficiencies that, if addressed, will significantly improve the company’s performance.
In Brazil, targets often have a unique characteristic: their family-owned nature. This scenario presents an interesting opportunity for search funds, which can act as facilitators in business succession. The majority of companies in the country were founded by families, and over generations, many family members no longer wish to take the business forward. In this context, founders deem selling their stake as an option to conclude their entrepreneurial chapter. Search funds, in turn, have stood out by enabling these transactions, while preserving the legacy built over decades.
Having introduced the main players, it is crucial to summarize the journey a search fund takes to reach its objective. The search fund cycle can be broken down into five main phases:
1) Initial Fundraising: The searcher raises funds from a few investors to search the market for a target company; typically, the investment is small (between USD 350,000 and USD 450,000). These funds are also used to compensate the searcher during this initial phase.
2) Search: Once capitalized, the searcher begins prospecting for potential targets. This involves making numerous phone calls, emails, video conferences, and in-person meetings with dozens, sometimes hundreds, of companies, and reviewing the information provided by potential targets.
3) Acquisition: After selecting a target, the searcher approaches the investors who participated in the Initial Fundraising phase, as well as other interested investors, to raise the necessary funds for the acquisition (unlike the Initial Fundraising phase, the amount raised here is significant, ranging from USD 5 million to USD 20 million).
4) Post-Acquisition (Post-Merger Integration – PMI): After the acquisition is completed, the searcher becomes the CEO of the target company and takes over its operations with the goal of improving management, reducing inefficiencies, and expanding the business.
5ª) Exit: After managing the target company until the investment maturity, the searcher and investors cash out their returns through an exit event (e.g., selling the target to a third party or taking it public through an IPO).
The above observations are based on extensive hands-on experience in the search fund industry, which began in July 2018 when we advised one of the first search funds in Brazil (Kinase Investments). Since then, we have continued working within this ecosystem, supporting various search funds at all stages mentioned above, facilitating deals, and building long-lasting partnerships.
Search funds hold great potential for growth in Brazil, especially in a challenging economic environment that encourages the search for investments with high returns and diversification. Not to mention the highly favorable market conditions in the country, with many mid-sized companies that have enormous growth potential.
