In software development, magic numbers are unexplained values that are “hard-coded” into code. Magic numbers are anti-patterns because they make it harder to understanding the underlying meaning of the code. By analyzing magic numbers, we can get a better understanding of what the designers of the application intended.
Once you hear about magic numbers, you start to see them all over the place. The world of search funds is no exception. Below, I wrote down a few examples of magic numbers I have noticed in search and some ways to think about them differently.
The Magic Numbers
The Search Period of 2 Years
The notion of a 2 year search is a very common magic number in the world of search.
One reason the search can take 2 years is due to the nature of assembling the pipeline and taking a deal to completion. Setting up the deal flow pipeline can take 6 months to start, and it can take anywhere from 6 months to a year to close out a deal.
Given these facts, an efficient entrepreneur would try to find ways to “avoid reinventing the wheel” by working for a searcher and gaining skill in pipeline development prior to raising funds. This would save the entrepreneur time and money that goes into the search. Furthermore, acknowledging the 2 year bias helps searchers avoid any Parkinson’s Law bias associated with the search period.
Ultimately, while entrepreneur and investor incentives are aligned by the fact that excess search funds are rolled into the investment as the searcher’s equity, it is still interesting that the community has settled on an equilibrium of 2 years despite the broadly known information about how to run a search.
Vesting in 3 Chunks of 8.33%1
The vesting schedule for a searcher typically involves three chunks of 8.33%. Like the 2 year funding window, this number has become common practice in the industry.
These three chunks all involve different types of work and value creation: one comes from buying the company, the other from operating it for a certain period of time, and the final one from selling the firm.
Given how vastly different these three events are, it would be interesting to consider other vesting schedules. For example, if investors have an extremely confident entrepreneur (which they almost always do), they may consider backloading the equity to the sale of the acquired firm.
Again, taking a closer look at the arbitrarily equal vesting split reveals interesting tradeoffs for searchers and investors to consider.
The Structure of Cap Tables: Raising $400k-500k from 6-10 Investors 2
Finally, search funds have converged on a common model for structuring the cap table of the fund. This makes sense: it is very risky to experiment on different models of incorporation.
In the case of putting together a cap table, searchers are advised to seek a diverse set of backers that can help with a broad variety of topics. This provides entrepreneurs with resources to successfully transition into becoming a first-time CEO. However, what is less discussed is what those broader sets of skills are. What are the highest leverage skills a board member can help with? Are they common or different across searchers?
Maybe we should think backwards here: instead of looking for 6-10 investors, searchers may be better off listing their distinct weaknesses and building a board around where they will need the most help.
Furthermore, investors may also consider how much money searchers need. Again, thinking backwards helps: do searchers need the $400-500k upfront? Or is there a way to fund searchers in stages?
Concluding Thoughts
Examing magic numbers reveals ways one can be more efficient about allocating their resources prior to and during a search. Magic numbers are an unintentional effect of incomplete design, whether in software or otherwise, and reveal opportunities for more thoughtful and deliberate exploration.
Going forward, it will be interesting to learn about ways in which investors and searchers structure their funds around magic numbers to achieve stronger incentive alignment.
Sources
- https://www.youtube.com/watch?v=0lg8Gh_uAPU&t=595s&ab_channel=AcquiringMinds
- https://www.pacificlake.com/intro-to-search-funds#stage-one