Direct Indexing 2.0: Building Your Own ‘Personalized S&P 500’ for Tax Alpha
Search Funds: The ‘Micro-PE’ Strategy with a Historic 35% IRR
COACHING POINTS
- The Concept: Investing in a Search Fund means backing a brilliant MBA grad (the “Searcher”) to find and acquire one boring, profitable small business (e.g., HVAC service, SaaS, Pest Control). You are betting on the jockey to find the right horse.
- The Economics: The “Silver Tsunami” of retiring Baby Boomers means millions of profitable businesses are for sale at low multiples (3x-5x EBITDA). Searchers buy these, modernize them, and grow them.
- The Returns: This is the best-kept secret in investing. Stanford GSB studies show an aggregate IRR of 35.3% and a Multiple on Invested Capital (MOIC) of 5.2x over the last 30 years.
You don’t need to find the next Google to get 100x returns. You just need to buy a profitable plumbing supply company in Ohio at 4x earnings and modernize its billing system. Search Funds are the vehicle for this. They allow you to play “Private Equity” with a micro-cap target, avoiding the intense competition and high valuations of the mid-market.
Investors in the initial “Search Capital” (funding the 2-year hunt) get a massive bonus.
- Initial Investment: You put in $35,000 to fund the search.
- The Acquisition: The Searcher finds a $10M company.
- The Bonus: Your initial $35k converts into equity at a 50% premium (Step-Up). You effectively start the deal with $52.5k of equity for a $35k check. Authority: Stanford GSB Search Fund Study
- Pro-Rata Rights: You also get the right to invest much more (e.g., $500k) into the acquisition deal itself.
What-If Scenario: Buying a “Boring” Business
Target: Commercial Cleaning Co. | EBITDA: $2M | Purchase Price: $8M (4x).
| Metric | Start (Year 0) | Exit (Year 7) |
|---|---|---|
| EBITDA | $2,000,000 | $5,000,000 (Growth + Margin Imp) |
| Valuation Multiple | 4.0x | 7.0x (Strategic Buyer Premium) |
| Enterprise Value | $8,000,000 | $35,000,000 |
Visualizing the Performance Alpha
*Figure 1: ROI Comparison. The Green line (Search Funds) significantly outperforms Top-Quartile VC and PE indices over long horizons.*
Execution Protocol
You don’t need to know a Stanford student personally. Platforms like Searchfunder.com or specialized Fund-of-Funds (e.g., Pacific Lake, Relay) aggregate these deals for Accredited Investors.
“Search Risk” is real. About 25% of searchers fail to find a company. Invest in a basket of 10-15 searchers ($20k-$30k each) to ensure you catch the winning deals. The loss on a failed search is small (just the search capital).
The real money is deployed when the acquisition happens. If you back a searcher, be ready to write a check for 10x-20x your initial amount when they find the target. This is where the compounding happens.
COACHING DIRECTIVE
- Do This: If you are an Accredited Investor with patience (5-7 years) and an appetite for “Main Street” risk. It diversifies you away from Silicon Valley tech hype.
- Avoid This: If you need immediate liquidity or cannot evaluate business models. Also avoid if you are not prepared for the “Capital Call” when a deal is found.
Frequently Asked Questions
What is a Search Fund?
It is an investment vehicle where investors back a promising entrepreneur (the ‘Searcher’) to find, acquire, and run a single privately held company. Unlike Venture Capital that funds ideas, Search Funds buy existing companies with proven cash flow.
How does it perform compared to PE?
Exceptionally well. According to Stanford GSB’s 2024 study, the aggregate internal rate of return (IRR) for traditional search funds is 35.3%, with a 5.2x Multiple on Invested Capital (MOIC). This outperforms most top-quartile PE funds.
What is the ‘Step-Up’ benefit?
Investors who fund the ‘Search Capital’ (the initial costs to find a deal) typically receive a 50% ‘Step-Up’ on their capital when the acquisition happens. For example, your $30k investment converts into $45k worth of equity.