How This PE Firm Scaled the Search Fund Model

What happens when a traditional PE fund incorporates a search fund model? NextGen Growth Partners (NGP), a Chicago-based private equity firm, has created this very thing.

Founded in early 2016, NGP is currently deploying its first fund using a hybrid model to support the firm’s entrepreneur-in-residence (EIR) program. The EIR program partners with entrepreneurial operators to assist them with finding, acquiring, and ultimately growing businesses in the lower middle market.

Thus far, most EIRs are MBA grads from the University of Chicago Booth School of Business due to the firm’s close ties to the school. This is not a requirement, however, and NGP is looking to partner with EIRs from other schools and backgrounds in the future.

In 2016, NGP raised a committed fund from a group of primarily Chicago-based investors who were familiar with the traditional search fund model and saw the opportunity to optimize that process with additional infrastructure and support. They also built a strong advisory board with successful business leaders like Dennis Chookaszian, former Chairman and CEO of CNA Insurance and Jim Perry, co-founder and Managing Director of Madison Dearborn Partners.

The fund invested in its first portfolio company in 2017 and has partnered with six EIRs to date.

“We’re very analogous to a traditional search fund, but we’re not a search fund. We are trying to take the best of the search fund model and the best of the traditional private equity model and apply it to making investments,” said Josh Dennis, a Vice President and founding member of NextGen.

NGP and its EIRs target companies that generate annual cash flow between $1M and $5M, and they focus on the business services sector. The EIRs work closely with the dedicated NGP team on the deal and then assume the CEO position within portfolio companies post-acquisition. Like a traditional PE model, NGP does look to eventually exit the acquired business but the fund is flexible on timing.

NGP’s fund typically provides 80% to 100% of the search and transaction capital for an acquisition. “We also encourage our entrepreneurs in residence to raise 10% to 20% of their search capital from outside investors. We think that helps bring valuable people into the NextGen network, it also allows EIRs to include family or friends or former co-workers want to invest in them,” said Dennis.

There are two reasons why NGP takes this approach:

“First, we found that having a dedicated fund that is fully backing these EIRs goes a long way with business brokers, investment banks, savvy business owners that start to ask questions around our ability to close. In the traditional search fund model, it’s not committed capital; it’s a right of first refusal. Having the commitment with our investment committee and advisory board behind that gives us a lot of credibility at the closing table,” said Dennis.

“Second, we think being the majority equity provider aligns well with our EIRs’ goals. We’re all highly motivated to make this work, with a focus on a limited number of EIRs and portfolio companies. There are pros and cons to each model of acquiring and operating a small business, and no single ‘right’ or ‘wrong’ way of going about this. The main difference between NGP and the traditional search fund model is that each EIR and portfolio company accounts for a significant portion of our fund, as opposed to the traditional model of each investor representing a minority position in the search with an option to fund the transaction.”

Dennis said there are currently five entrepreneurs “residing” at NGP full time. “The length of the ‘residence’ is based on how long it takes them to find a business,” Dennis said. “They are here in Chicago at our office full time during the search phase, then they go to wherever the business is located.”

Dennis said NGP sources their opportunities in a few different ways, but let the EIRs drive the process. Dennis noted that each EIR is conducting three “deep dives” at any given time. “As one rolls off, they bring another one on,” he said. “And then on top of that, we do a lot of outreach to business brokers, investment banks, and other intermediaries.”

Going back to why NGP is pursuing a hybrid PE-search fund model in the first place. Dennis said the firm’s founder and managing partner, Brian O’Connor, ran a search fund named Fellowship Capital Partners in 2011, through which he acquired and operated a business called Innflux, and he was inspired to help other young entrepreneurs search for the right businesses in the most efficient way.

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