The field of impact investing is growing rapidly with nearly $114 billion of total impact assets currently under management. As the sector continues grows, the need for new and innovative impact investment products will also increase. Investors have an opportunity to more deeply transform companies and industries for social and environmental benefit by introducing an entirely new impact asset class: Impact search funds.
SSG Advisors is pioneering the design and launch of the world’s first such fund. With the right supports in place to support stakeholders, we believe this adapted approach can have broad appeal among entrepreneurs and impact investors.
What Are Search Funds?
Search funds are a little-known but proven private equity investment vehicle. They were originally conceived at Stanford in the 1980s as a way for recent MBA graduates to acquire and grow established small- to medium-sized businesses. Unlike other investment vehicles, search funds target profitable, mature companies in growth industries with earnings before interest, tax, depreciation and amortization (EBITDA) of $1 million to $5 million and total value in the range of $5 million to $20 million. As such, search funds target deals that are too small for institutional investors, but too large for most angel investors. Search funds are typically led by relatively inexperienced but talented entrepreneurs, often recent MBA graduates from top business schools. These individuals hope to become CEOs early in their careers, yet may not have the desire or an idea to start their own business. Instead, these individuals pursue entrepreneurship through acquisition.
The search fund model allows investors to source, mentor, and partner with high-caliber entrepreneurs who ultimately will be responsible for operating the acquired companies. Investors are afforded an extended period for due diligence on the search entrepreneur before a significant capital commitment is required.
Search funds have proven quite profitable. A 2013 study by the Stanford Graduate School of Business found that the approximately 300 search funds raised since 1983 averaged an 8.4 times return on investment and an internal rate of return of more than 36 percent.
Adapting the Search Fund Model
We believe the impact investing industry can readily adapt the search fund model by including impact criteria (metrics such as potential to reduce greenhouse gas emissions or supply chain transparency) during both the search and operations phases of the process. The goal of these impact search funds would be to acquire successful traditional businesses, and achieve long-term growth by dramatically improving their social and environmental performance, thereby generating both impact and profits. To assess the feasibility of this new idea, SSG undertook a proof-of-concept study on the Thai aquaculture industry, an important economic sector with a long history of deep social and environmental problems.
SSG’s impact investment team completed a thorough industry and sustainability analysis to identify three promising seafood industries that fit the impact search criteria: white-legged shrimp, black tiger shrimp, and tilapia. The team then conducted an in-country field assessment by engaging a broad range of industry stakeholders with a specific focus on identifying trends, risks, and potential investment opportunities. We then focused on firms that had the potential for significant growth and outsized impact in their market segment. Through this process, the impact investment team identified two promising potential acquisition opportunities: a polyculture shrimp farm and a thriving seafood marketplace, both of which fit traditional search fund investment criteria and also had the potential to have transformative impacts in their respective market segments.
After three months market testing the idea in the Thai aquaculture industry, we created an initial concept note and drafted an initial investment prospectus, which is still in progress. The market testing included many of the activities normally undertaken by a searcher: identifying potential markets, talking with potential investors, and developing an initial pipeline. However, SSG concluded that it was not feasible for the firm to launch an impact search fund itself given that it requires a dedicated, full-time search entrepreneur. (SSG continues to support the initiative, which an individual affiliated with the firm is pursuing.) Nevertheless, given the potential benefits and impacts of impact search funds, SSG is now in the process of establishing an impact search fund accelerator, which will aim to attract talented entrepreneurs while simultaneously building the ecosystem necessary support the impact search funds. We are actively developing partnerships with stakeholders within the traditional search, impact investing, entrepreneurship, and business school communities. We anticipate launching its initial events before year’s end in Boston, Chicago, and the Bay Area.
Establishing Impact Initiatives from the Inside
Impact investments typically seek to disrupt industries through external pressures by supporting innovative but unproven business models. By contrast, impact search funds seek to disrupt industries from within by acquiring successful businesses, implementing robust sustainability initiatives in their operations, and demonstrating superior returns. Impact search funds represent a particularly powerful tool for investors looking to address social and environmental issues―such as human trafficking and deforestation―within opaque industries and supply chains dominated by businesses that are privately owned or family-owned.
The potential benefits of impact search funds are clear. But if these funds are to become a useful impact-investing tool going forward, we have our work cut out for us. We must:
- Develop a new impact investment class by identifying sectors where the initial search fund concept could be applied and structuring initial investment opportunities, and create deal flow pipelines for impact capital deployment and exit strategies.
- Create new career tracks and opportunities to attract more talented impact entrepreneurs. (SSG is planning to host several impact search fund events in cities across the United States to promote the concept.)
- Leverage well-established resources within the community to support impact search funds and the next generation of impact entrepreneurs.
- Integrate existing search fund coursework and research into social enterprise centers and impact-focused initiatives at top business schools. The idea has already met with support in early conversations with several universities.
The field of impact investing is expanding rapidly, and investors have the opportunity to improve financial, social, and environmental impact through search funds. We believe this approach could be an effective and less costly alternative to building new endeavors by introducing an entirely new impact asset class.