Fast Money

Many bright young sparks fresh out of business school dream of owning a company. But faced with the daunting prospect of raising money without operating experience, most take a well-trodden path, ending up at consulting or investment-banking firms. A form of financing bred on the campuses of Stanford and Harvard business schools offers an alternative.

It's known as a "search fund," and it works like this: Young M.B.A. decides to buy a company. M.B.A. persuades a dozen or so investors to ante up a limited sum, perhaps $20,000 apiece. For the next one to three years, the M.B.A. uses that money to look for a company to acquire--ideally, in an industry in which the M.B.A. has some expertise--while collecting a modest salary (say, $50,000). Once the M.B.A. identifies a suitable and willing seller, the original investors are guaranteed the right to invest a much larger sum, like $300,000, for a chunk of the company's equity. Assuming the investors like the company as much as the M.B.A. does, then voilĂ, the M.B.A. soon realizes the dream of business ownership.

Since the mid-1980s, when Continental Cablevision cofounder and business-school lecturer Irv Grousbeck developed the search-fund concept with a group of students, 15 of his former students at Harvard and Stanford have successfully replicated the formula (there have been four failures) and at least 6 others are currently trying to do so. One of them, Doug Wells, calculated that, on average, the successes have produced a 40% internal rate of return.

Some marvel at investors' willingness to fork over money to an unseasoned graduate. "It's arrogant to imagine that you're going to come in and suddenly make a lot of good things happen," offers Harvard Business School professor William Sahlman, who says he's seen several M.B.A.'s purchase small companies with the naive belief that the financial analysis they learned in the classroom will be enough to turn the business around.

Perhaps John Moran, a Harvard M.B.A. in the midst of the search process, has assuaged his investors' fears by assuring them he'll buy a company with a steady cash flow, not a turnaround that requires Herculean management skills. Out of his tiny $318-a-month San Francisco office, he's using his search fund, Redwood Partners Inc., to look for an occupational-training company with strong growth potential and a price tag between $15 million and $60 million. Moran admits that he will give up more equity--75%, which is comparable with the amount given up in most search-fund deals-- than he would without a search fund. But he can scarcely conceive of buying a company without one. "You certainly wouldn't have the time and resources to uncover a really sweet deal," he says.