You Spent Two Years Finding the Right Business. Here Is What Goes Wrong After Close.
The headline figure from the Stanford GSB 2024 Search Fund Study is the one that gets shared at conferences and quoted in pitch decks: a 35.1% aggregate pre-tax IRR across all search funds since 1984. It is a compelling number. It is also, for the purposes of deciding whether your acquisition will succeed, almost entirely irrelevant.
The number that matters is the one that appears two pages later in the same study: 31% of acquired companies produced negative returns to investors.
Nearly one in three. Not slightly below target. Negative.
This is not a headline you will see in the ETA community's promotional materials. But it is the number that should shape how you approach the operational side of your acquisition — and specifically, what you do about it before you close.
What the Study Does Not Tell You
The Stanford data is rigorous and valuable. What it cannot tell you, because it was not designed to, is why those 31% of acquisitions produced negative returns.
The study tracks outcomes. It does not track causes. Financial due diligence reports do not track causes either — they validate historical earnings and identify legal and contractual risk. By the time a deal closes, the financial picture has been examined from multiple angles by multiple advisors.
And yet nearly a third of acquisitions still fail to generate a return.
The explanation is not in the numbers. It is in what the numbers were built on.
Most search fund targets are founder-led, owner-managed SMEs. The founder built the business over a decade or more. They know every customer, every supplier, every workaround in the system. They are the business, in a more literal sense than most buyers appreciate when they are deep in a data room reviewing EBITDA adjustments.
When you close, the founder starts leaving. What happens to the business in the months that follow is determined almost entirely by what you found out — and what you did about it — before you signed.
The Three Operational Failure Modes
From our work on search fund acquisitions across a range of industries, the negative-return cases tend to share one or more of three operational failure patterns. None of them show up clearly in financial due diligence. All of them are identifiable before close if you know where to look.
1. The Business That Only Works With the Founder Present
This is the most common pattern, and the most misunderstood. It is not simply about the founder being "hands-on." It is about the business having been structured, over many years, in a way that makes the founder structurally indispensable.
The customers call the founder directly. The key supplier relationships were built on a personal handshake over fifteen years. The production manager who keeps the floor running defers every unusual decision upward because the founder has always been there to make it. The business has never needed to function without him, so it has not developed the capability to do so.
You will not discover this by reviewing the org chart. You will discover it by asking a different set of questions: who has spoken to the top five clients in the past six months, and in what capacity? What decisions cannot be made in the founder's absence? What happens to the supplier relationship if the founder is no longer the contact?
These questions feel uncomfortable to ask in a negotiation. They are less uncomfortable than inheriting the consequences of not asking them.
2. The Systems That Work Because Someone Compensates for Them
Most founder-led businesses are not run on best-in-class operational infrastructure. They are run on a combination of functional systems, personal relationships, undocumented workarounds, and the institutional memory of one or two long-tenured employees.
This is not a criticism of the founder. Building operational infrastructure is expensive and time-consuming, and founders allocate their energy to what drives revenue. The result is that the business often runs well in practice, but for reasons that are not visible in the systems themselves.
In due diligence, you review the ERP, the CRM, the financial reporting stack. They look adequate. What you are not seeing is the operations manager who knows that the inventory system double-counts a specific SKU category every month and adjusts manually. Or the office manager who maintains the actual accounts receivable position in a spreadsheet because the system does not handle partial payments correctly. Or the founder who calls the top client personally every quarter not as a relationship touch but because the client complained three years ago and has never fully trusted the account management team since.
When these people leave or disengage, the systems do not suddenly fail. They degrade. Slowly, then all at once.
The question to ask in due diligence is not "do you have systems?" It is "show me how a routine process runs end-to-end, without the founder's involvement, and walk me through the last time something went wrong and how it was resolved."
3. The Transition That Was Planned But Not Designed
Virtually every search fund acquisition includes a transition plan for the exiting founder. In most cases, it amounts to: the founder stays on for three to six months, introduces the new CEO to key stakeholders, and is available for questions thereafter.
This is not a transition plan. It is a schedule.
A genuine transition plan specifies, for each critical dependency, what the risk is, who holds it, what the plan is to transfer it, and what the success condition looks like. It treats founder transition as an operational workstream with defined milestones, not as a courtesy period that runs alongside the real work of taking over the business.
The difference between the two becomes apparent in the first ninety days after close, which is also when your investors, your board, and your team are forming their first real impressions of your leadership. It is not the moment you want to discover that the founder's departure triggered three customer conversations you did not know were at risk.
What This Looks Like in Practice
Consider a typical search fund acquisition: a B2B services business, twelve employees, EBITDA margins in the mid-twenties, founder retiring after twenty-two years. Financial due diligence is clean. Legal review is straightforward. The quality of earnings report is solid.
What financial due diligence does not surface:
- Two of the top three clients have personal relationships with the founder that predate the formal contracts. Neither has ever dealt with the incoming CEO. One has already mentioned to a supplier contact that they are "watching how this transition goes."
- The operations lead, who is functionally running the business day-to-day, has been offered a position at a competitor. She has not accepted yet, but she has been thinking about it since the sale was announced.
- The firm's largest recurring contract contains a change-of-control clause that allows the client to renegotiate pricing on a change of majority ownership. The clause is in the contract. The contract was in the data room. It was not flagged because it is a standard clause and the financial model assumed contract continuity.
None of these are unusual. All of them are identifiable before close with the right operational assessment. All of them have a path to mitigation if you know about them in advance. None of them are recoverable surprises if they land in your first thirty days as CEO.
The Asymmetry of the Search Fund Position
There is a structural feature of the search fund model that makes operational risk management more important than it is in a conventional PE acquisition, and it is worth naming directly.
In a private equity fund, a failed acquisition is painful but survivable at the portfolio level. The fund has other investments, and the diversification effect absorbs underperformance.
You do not have a portfolio. You have one company, and you are betting five to ten years of your career on it, along with your investors' capital and your own equity. The asymmetry between an excellent outcome and a negative one is not just financial. It is personal and professional in a way that no IRR average can capture.
This is not an argument for caution. It is an argument for precision. The founders who produced the 35.1% aggregate IRR did not get there by being lucky. They got there by understanding what they were buying, operationally, before they bought it — and by building a transition plan that was equal to the actual complexity of the business.
What Operational Due Diligence Addresses
An operational due diligence engagement on a search fund acquisition is not a checklist exercise. It is a structured programme of assessment focused on the questions that financial and legal diligence cannot answer.
It maps where power, knowledge, and relationships actually sit, as distinct from where the organisational chart says they sit. It tests the operational infrastructure against the demands of new ownership rather than against the habits of the current owner. It identifies the specific risks that will become your problems on day one, and it produces a prioritised transition plan that reflects the real complexity of the handover, not the idealised version.
The objective is not to surface reasons to walk away from an acquisition. In most cases, the risks are manageable if they are understood. The objective is to ensure that the price you are paying reflects the operational reality of what you are acquiring, and that you close with a clear plan for the first ninety days rather than discovering it through experience.
For a first-time CEO taking on a single company, that preparation is not a luxury. It is the difference between the 35.1% and the 31%.
Frequently Asked Questions
Why do so many search fund acquisitions produce negative returns despite strong aggregate IRR? The 35.1% aggregate IRR reported in the Stanford 2024 study reflects the full distribution of outcomes, including a small number of very high-return exits that pull the average up significantly. The 31% negative-return figure reflects the acquisitions at the other end of that distribution. The gap between the two is largely explained by operational factors that financial and legal due diligence does not reliably surface: founder dependency, undocumented operational knowledge, and inadequate transition planning.
What is the most common operational failure in search fund acquisitions? The most consistent pattern is acquiring a business that is more dependent on the founder than the financial metrics suggest. Revenue and EBITDA can look stable for years because the founder is present and managing the critical dependencies personally. The fragility only becomes visible once the founder begins to disengage, which is typically in the months immediately after close.
How is operational due diligence different from financial due diligence in a search fund context? Financial due diligence looks backward, validating earnings quality and identifying contractual risk. Operational due diligence looks forward, assessing whether the business can sustain its performance under new ownership without the founder's involvement. In a search fund acquisition, where the new owner is also the incoming CEO and has no portfolio to absorb underperformance, the forward-looking assessment is at least as important as the backward-looking one.
When in the acquisition process should operational due diligence happen? Ideally, operational due diligence runs in parallel with financial and legal due diligence during the confirmatory phase, after LOI and before close. The findings should directly inform the transition plan, the first-100-days priorities, and where relevant, the negotiation of the purchase price or deal structure. Operational due diligence conducted after close is integration consulting — useful, but it does not reduce the price you paid for risks you did not see.
Does operational due diligence make sense for smaller search fund acquisitions? The scale of the engagement should be proportionate to the deal. A business with five employees and a simple operational model requires a different scope than a business with fifty employees, multiple locations, and complex supplier relationships. The relevant question is not whether the business is large enough to warrant it, but whether the operational risks are complex enough that a first-time CEO, deep in the transition, is the best person to identify and manage them without independent assessment.
If you are approaching close on an acquisition and want an independent view on the operational risks before you sign, we are always happy to have that conversation.
Diadem Advisory E: innovation@diadem.co.za W: www.diadem.co.za
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Disclaimer: This article is for informational purposes only and does not constitute legal, financial, investment, or professional advice of any kind. The content reflects Diadem Advisory's general views on operational due diligence practice and should not be relied upon as advice specific to any transaction, business, or set of circumstances. Readers should obtain independent professional advice before making any transaction-related decisions.
AI Disclosure: This article was developed with the assistance of AI tools and reviewed and edited by Diadem Advisory. All analysis, opinions, and professional judgements are those of Diadem Advisory and reflect the firm's own experience and expertise. AI was used as a drafting and research aid only.
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