Search Funds vs. Private Equity: Which Offers Better Long-Term Returns?

The landscape of private investing offers various avenues for capital deployment, each with its unique structure, risk profile, and return potential. Among these, traditional Private Equity (PE) has long been a dominant force, managing vast sums and acquiring diverse portfolios of companies. However, a distinct model, the Search Fund, has gained significant traction, particularly among aspiring entrepreneurs and investors seeking a different kind of engagement and potentially higher returns. 

This raises a crucial question for investors: which model, Search Funds or Private Equity, offers better long-term returns? 

Understanding the Models: Search Funds vs. Private Equity

Search Funds

The search fund model typically involves one or two entrepreneurs (often recent MBA graduates or mid-career professionals) raising a small amount of initial capital from a group of investors. This initial capital funds a dedicated search (usually 1-2 years) to identify, acquire, and then operate a single, established, profitable small-to-medium-sized business (SMB). The entrepreneurs become the CEO/management team of the acquired company, focusing all their efforts on operating and growing that single entity, typically aiming for an exit in 4-10 years. Investors benefit from backing a dedicated operator whose interests are highly aligned with theirs through significant equity incentives. 

Private Equity

PE firms operate on a much larger scale. They raise substantial funds (often billions) from institutional investors (pensions, endowments, sovereign wealth funds) to acquire multiple companies. PE investments can range from minority stakes in high-growth companies (growth equity) to controlling stakes in mature businesses, often using significant leverage (debt) in leveraged buyouts (LBOs). PE firms typically install new management or work closely with existing teams, focusing on operational improvements, financial engineering (like debt reduction), and strategic repositioning to increase value before exiting through a sale or IPO. Returns are driven by a portfolio effect, manager skill across multiple deals, and often, the use of leverage.

Search Fund Returns

The allure of search funds often centers on their potential for exceptional returns. Data, primarily tracked by Stanford Graduate School of Business (GSB) since 1984, provides compelling evidence. Stanford Business School’s 2024 annual report on search fund returns found the reported returns was 42.9% for all funds.

While the aggregate search fund returns are impressive, performance varies significantly. Success hinges heavily on the searcher’s ability to find a good company at a fair price and effectively operate it.

A key driver of high search fund returns is the direct impact of the entrepreneur-CEO, whose equity stake strongly aligns their interests with investors. This hands-on, focused leadership can unlock growth in smaller companies that might be overlooked by larger PE firms. 

Private Equity Returns

Private equity has a longer, more established track record as an institutional asset class, known for delivering strong long-term returns, often outpacing public markets.

PE returns are typically attributed to three main levers: 

• Operational Improvements: Enhancing efficiency, growing revenue, cutting costs. This has become increasingly important as reliance on financial engineering decreases.
• Deleveraging: Using the company’s cash flow to pay down acquisition debt, thereby increasing the equity value.
• Multiple Expansion: Buying a company at a certain valuation multiple and selling it at a higher multiple, driven by growth, market conditions, or strategic improvements.
• Diversification and Scale: PE funds invest across multiple companies, providing diversification benefits that mitigate the single-asset risk inherent in search funds. They target larger companies than search funds and deploy significantly more capital. However, PE funds typically charge higher fees which impact net returns to investors.

Comparing Long-Term Returns: Which is “Better”?

Direct comparisons are challenging due to differences in data reporting, risk profiles, and investment structures. 

On a gross basis, aggregate historical search fund returns appear significantly higher than average PE returns. However, search fund returns exhibit much wider dispersion, meaning higher risk of lower or negative outcomes for any single investment, but PE returns, while variable, tend to be more predictable due to portfolio diversification.

Search funds represent a concentrated bet on a single company and a single operator. PE offers diversification across multiple companies, industries, and potentially geographies, smoothing overall returns.

Tailoring Investment to Objectives

Both Search Funds and Private Equity offer compelling pathways to potentially strong long-term returns within the private markets. Historically, aggregate search fund returns have been exceptionally high, driven by the focused efforts of dedicated entrepreneurs operating a single acquired business. 

However, these impressive search fund returns come with considerable variability and concentration risk. Private Equity, while perhaps offering lower average returns across the asset class compared to the search fund aggregate, provides diversification benefits and access to larger, more established investment managers and deals. The choice between them is not about inherent superiority but about aligning the investment model with an investor’s specific risk tolerance, return expectations, desire for involvement, and capital allocation strategy. Search funds present a high-potential, high-alignment model focused on entrepreneurial drive, while PE offers a more diversified, institutionally established approach to private market value creation.

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Reviewed and edited by Albert Fang.

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Article Title: Search Funds vs. Private Equity: Which Offers Better Long-Term Returns?

https://fangwallet.com/2025/05/14/search-funds-vs-private-equity-which-offers-better-long-term-returns/

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