In the early 1980s, Irving Grousbeck and his colleagues at Stanford Business School launched a revolution in the way that entrepreneurs and investors fund, manage, and grow mature businesses. Their creation — the search fund — changed the way many investors thought about equity investments, turning fund managers into quasi private equity shops and posting impressive returns as a result.
One way to think about the search fund model is by comparing it to the three factors that go into a winning thoroughbred team: the jockey, the trainer, and the horse.
In the context of the traditional search fund, the jockey is the bright aspiring operator who goes out into the market to “search” for existing businesses that are ripe for acquisition and then manages them after the fact. The trainer is the investor, who provides the capital to pay for the acquisition and provides mentorship and board oversight. And the horse is the company that the search fund acquires and positions for accelerated growth.
It’s a proven model, and one that works very well, averaging 34-37 percent annual returns over more than two decades.
Search fund investments are typically focused on businesses that aren’t innovation-driven, like cell phone insurance, logistics services, and home security. But, as I’ve been collaborating with universities on a few different fronts, I’ve started to believe that this type of approach could solve a big problem universities face: finding a way to invest in and commercialize the technologies that are born out of their own research institutions.
Right now, universities are faced with several challenges. Researchers, commercialization offices, and entrepreneurship offices are coming to their endowments looking for capital to support their projects. The institution wants to see more commercialization of its technologies and research, but the stringent rules governing the endowment prevent it from investing directly in early stage companies or funds that are affiliated with university assets.
I’ve discussed the idea of a “venture search fund” with both university endowments and researchers, and it seems to resonate.
Some Chief Investment Officers at major university endowments have shared with me that they are frustrated with the current restrictions they face and that they believe a venture search fund model would solve their structural problems. As a VC that straddles the Valley and the Midwest, another theme that’s always on my mind is how to help propagate an innovation mindset throughout middle America – and universities are often the hub around which innovation ecosystems develop.
So I believe it’s time for universities and VCs to start experimenting with this kind of model.
Let’s take a closer look at how it could work.
First, let’s take a closer look at the problem that needs solving.
Members of university investment committees are often volunteers who face enormous pressure to find assets that will yield high IRR for their institutions, at low risk. Committee members typically face too many obstacles to make any sort of meaningful investment that meets their fiscal goals and conforms with their well-intentioned investment policies.
Sound investment policies are preventing these groups from investing in and supporting early-stage companies associated with the very institution they are created to serve.
At the same time, universities need talented leaders to help commercialize the technologies that are coming out of their research labs. The entrepreneur-in-residence (EIR) model has been one of the most popular ways for universities to address this gap, but these programs rarely increase an institution’s chances of successful commercialization.
As a result, university endowments don’t have sufficient funding to attract talented entrepreneurs, and the most promising investment opportunities — that could have a massive impact on the local community — may be walled off from large investors.
Adapting the model
The venture search fund model would offer a potential solution by allowing university endowments to invest in independent venture funds with diverse portfolios, while also supporting their own commercialization efforts.
Today, any entrepreneur can approach a university to license research. They then have to look for their own funding, and in the event their venture fails, the value of that research is lost. Whatever the case, the university gets only a one-time licensing fee. But under the venture search model, the university, together with a partnering VC firm, would actively search for an experienced, talented entrepreneur to lead the effort, and the university would have the opportunity for a much greater return.
By partnering with a university’s entrepreneurship office this way, these entrepreneur “jockeys” would have the runway to explore their business concepts, and they would be incentivized to license technologies from sponsoring universities. This would give endowments access to high-growth commercialization opportunities and, by partnering with experienced venture capital firms, would mitigate the risk involved in these types of early-stage investments.
Importantly, the jockey would not be limited to the ideas, talents, or research being generated by the university. They would be operating in the open marketplace of ideas and capabilities, like any great, innovative founder.
Rewarding big ideas
Understandably, university endowments are risk-averse.
But the challenges that institutions face are universal, and a number of universities I’ve spoken to are currently considering this approach. The venture search fund offers a safe, risk-averse option for endowments looking to support their own commercialization efforts. It deserves a closer look.
Tim Schigel is a partner at Refinery Ventures, Founder & Chairman at ShareThis, proud dad, and part-time guitar slinger. Refinery Ventures has been pursuing venture search fund arrangements with select universities.