Financing Structure and Deal Structures in Search Funds: How is the Business Acquisition Designed?

The financing structure is a central element of every search fund transaction and significantly determines the long-term success of the venture. Unlike traditional acquisitions, search funds are characterized by specific capital structures and ownership models that address the unique requirements of this succession form. This article sheds light on the various financing options and deal structures in search funds.

What does the typical financing structure of a search fund look like?

Search funds are distinguished by a multi-stage financing process that reflects the different phases of the venture.

The two financing stages of a search fund

In a classic search fund, financing occurs in two clearly separated phases:

Phase 1: Search Capital
Search capital finances the search phase and typically covers the following costs:

• Salary of the searcher for 18-24 months
• Travel and research expenses
• Initial due diligence costs
• Administrative expenses (office, software, etc.)

The typical amount of search capital ranges between €300,000 and €500,000. This sum is usually raised from 10-20 investors in equal shares, with each investor contributing approximately €20,000-€50,000.

Phase 2: Acquisition Capital
After identifying a suitable acquisition target, capital is raised for the actual business purchase. This includes:

• Equity for the acquisition
• Arrangement of debt financing
• Reserves for working capital
• Budget for initial improvement initiatives

The amount of acquisition capital varies depending on the company size but typically ranges between €2 million and €15 million.

Overall financing structure of a typical search fund acquisition

An average search fund transaction features the following capital structure:

Source of Capital	Typical Share	Description
Equity	30-50%	Capital from investors and, if applicable, the searcher
Senior Debt	30-50%	Bank loans with first-ranking security
Mezzanine	0-20%	Subordinated loans or hybrid financing instruments
Seller Loan	10-30%	Deferred purchase price portion from the seller
Earn-Out	0-20%	Performance-based future payments to the seller

The exact distribution depends on various factors, including industry, cash flow stability, collateral, and negotiation outcomes with the seller.

What equity sources are available to search funds?

Equity for search fund transactions originates from various sources, each playing different roles in the overall process.

1. Search fund investors

The primary source of equity is specialized search fund investors:

• Experienced search fund investors: Investors with a proven track record in this segment
• Family offices: Wealth management entities of affluent families
• Business angels: Former entrepreneurs with industry experience
• Institutional investors: Increasingly specialized funds for search funds

These investors are characterized by a long-term investment horizon and an understanding of the search fund model. Besides capital, they often provide strategic advice and network access.

2. Searcher's own funds

Depending on the search fund model, the searcher also contributes personal capital:

• Traditional model: Small equity contribution (typically 1-5% of search capital)
• Self-funded model: Full self-financing of the search phase
• Hybrid models: Partial financing of the search phase by the searcher

The amount of equity contributed directly influences the searcher's eventual ownership stake in the acquired company.

3. Co-investments

For larger transactions, additional equity sources are often tapped:

• Co-investment by existing investors: Increase by search capital investors
• New equity providers: Specifically for the acquisition phase
• Strategic partners: Industry players with strategic interest

These supplementary equity sources enable financing of larger acquisitions but can complicate governance structures.

What debt sources do search funds use?

Debt financing plays an important role in most search fund transactions to optimize capital structure and returns.

1. Bank financing

Classic bank financing includes various products:

• Acquisition financing: Specifically for the business purchase
• Working capital lines: To finance working capital
• Investment financing: For specific assets or expansions

In the DACH region, house banks are traditionally important partners who often remain long-term financing partners after the acquisition.

2. Subsidies and public financing

Especially in German-speaking countries, public institutions offer attractive financing options:

• KfW Entrepreneur Loan: Standard financing program for acquisitions
• ERP subsidies: Specifically for business succession
• Guarantee banks: Securing bank loans through public guarantees
• Regional funding programs: Additional support depending on location

These financing sources are characterized by favorable terms and often longer maturities but usually require longer lead times.

3. Alternative debt sources

Besides classic bank loans, search funds increasingly use alternative financing forms:

• Private debt funds: Specialized funds for mid-market acquisition financing
• Mezzanine capital: Subordinated loans with equity-like characteristics
• Unitranche financing: Combination of senior and junior debt in one facility
• Asset-based lending: Secured by specific assets

These alternative sources often offer greater flexibility in structuring but are typically more expensive than classic bank financing.

What deal structures are common in search funds?

The transaction structure itself can take various forms and is adapted to the specific circumstances.

1. Share deal vs. asset deal

The fundamental choice between purchasing company shares or assets has far-reaching implications:

Share Deal

• Acquisition of the company as a legal entity
• Continuity of contracts and approvals
• Assumption of all rights and obligations
• Typically preferred by sellers due to tax advantages

Asset Deal

• Selective acquisition of assets
• No automatic assumption of liabilities
• Opportunity for asset revaluation
• More complex execution due to individual transfers

The choice between these basic forms is primarily influenced by tax, liability, and operational factors.

2. Holding structures

Search funds often implement multi-tiered corporate structures:

• Acquisition holding: Vehicle for acquiring the target company
• Management holding: For the searcher's participation
• Investor holding: Consolidation of investor stakes
• Country holdings: For international structures

This structure enables optimal tax planning and clear governance arrangements among the various stakeholders.

3. Earn-out structures

Earn-outs are particularly common in search funds as they serve multiple functions:

• Bridging valuation gaps between buyer and seller
• Binding the seller during the transition phase
• Hedging against forecast risks
• Spreading financing needs over several years

Typical earn-out parameters include EBITDA targets, revenue growth, or specific milestones such as customer retention or product launches. The term usually ranges from 2 to 5 years.

4. Seller loans and vendor notes

Seller loans are an important structuring element:

• Bridging financing gaps
• Demonstrating the seller's confidence in the company's future
• Flexibility in payment terms (subordinated, interest-only, performance-based)
• Reducing external capital requirements

Typically, seller loans account for 10-30% of the purchase price and have terms of 3-7 years.

How are ownership shares distributed in search fund transactions?

A distinctive feature of search funds is the specific distribution of ownership shares designed to create incentives for all parties involved.

Typical ownership distribution after acquisition

Stakeholder	Ownership Share	Remarks
Searcher	20-30%	Typically structured as vesting shares
Search capital investors	10-20%	Including step-up for search financing
Acquisition capital investors	50-70%	Proportional to capital contribution
Management/employees	0-5%	Optional for key personnel
Seller	0-20%	In cases of partial ownership retention

Vesting models for the searcher

The searcher's ownership stake is typically subject to a vesting model:

• Time-based vesting: Gradual earning over 4-5 years (e.g., 20% per year)
• Performance-based vesting: Linked to achieving specific company goals
• Combined models: Partly time-based, partly performance-based
• Accelerated vesting: Accelerated upon reaching certain milestones

These models ensure the searcher remains committed long-term and incentivized for the company's successful development.

The step-up mechanism for search capital investors

A unique feature of the traditional search fund model is the step-up for early investors:

• Basic principle: Investors in the search phase receive a preference in ownership distribution
• Typical magnitude: 1.5 times the value of the invested search capital
• Implementation: Either as preferred equity or additional common shares
• Rationale: Compensation for the higher risk of search phase financing

This mechanism is a key incentive for investors to engage early in the high-risk search phase.

What tax and legal aspects must be considered?

The financing and deal structure have significant tax and legal implications that must be carefully planned.

1. Tax optimization

Tax structuring significantly affects after-tax returns:

• Deductibility of financing costs: Structuring debt financing
• Loss carryforwards: Preservation and utilization of existing tax losses
• Depreciation potential: Tax optimization through asset step-up
• International tax planning: For cross-border structures
• Taxation of management equity: Optimization of the searcher's participation

Early tax planning involving specialized advisors is crucial for overall profitability.

2. Legal documentation

The legal framework includes various key documents:

• Purchase agreement (SPA): Governs the transaction itself, including warranties and representations
• Shareholders' agreement (SHA): Defines rights and obligations of equity holders
• Financing agreements: Documentation of all debt elements
• Vesting agreements: Legal structuring of the searcher's participation
• Management contracts: Regulations on management and compensation

Careful drafting of these documents is essential to avoid future conflicts and establish clear governance structures.

3. Regulatory aspects

Depending on the industry and transaction size, various regulatory aspects must be considered:

• Merger control: Required approvals above certain thresholds
• Industry-specific permits: Especially in regulated sectors such as financial services or healthcare
• Labor law requirements: Information and consultation obligations
• Data protection aspects: Particularly for data-intensive business models

How are financing structures evolving in search funds?

The financing landscape for search funds is dynamic and subject to continuous development.

1. Current trends

In recent years, several clear trends have emerged:

• Increasing institutionalization: Specialized funds for search fund investments
• Higher valuations: Competition for attractive targets leads to rising multiples
• More creative financing structures: Hybrid models between equity and debt
• Longer holding periods: Trend toward longer investment horizons
• Permanent capital models: Development of structures without defined exit

These trends lead to increasing professionalism and diversity in the search fund ecosystem.

2. Differences in the DACH region

Compared to the US market, where the search fund model originated, the DACH region shows some particularities:

• Stronger bank orientation: Greater importance of traditional bank financing
• More conservative leverage ratios: Typically lower debt levels
• Significance of public subsidies: Greater use of government financing programs
• Family offices as key investors: Special role of family businesses as capital providers
• Longer due diligence processes: More comprehensive pre-transaction reviews

These regional characteristics shape financing and deal structures in the German-speaking area.

3. Future developments

Further developments are anticipated in the coming years:

• ESG integration: Increasing consideration of sustainability criteria
• Digitalization of processes: More efficient transaction execution
• Specialized debt funds: New providers of debt beyond traditional banks
• International expansion: Increasingly cross-border search fund activities
• More innovative ownership models: New approaches to employee and community participation

Conclusion: Success factors for financing search funds

The financing structure and deal design are decisive success factors for search funds. A balanced capital structure lays the foundation for sustainable success after acquisition and enables the implementation of planned growth strategies.

Successful search fund financings are characterized by a careful balance between different capital sources. They provide sufficient financial flexibility for operations and unforeseen challenges while creating clear incentive structures for the searcher and all stakeholders.

Early involvement of experienced advisors for tax, legal, and financial aspects is as important as open and transparent communication with potential capital providers. Especially in the DACH region, where the search fund model is not yet as established as in the US, clear communication of the advantages of this succession form is crucial for all parties involved.

With a well-thought-out financing and deal structure, search funds offer an attractive alternative for business succession that meets the interests of sellers, investors, and the searcher alike and ensures the long-term development of the acquired company.

Considering acquiring a company? Learn how to buy a business with little equity or explore which financing options are available for your business purchase.