Fresh out of business school, Chris Lueck and Tom Tzakis wanted to run an established, profitable company. But rather than toiling for years to achieve that goal, the USC graduates are taking an unusual path that could get them there a lot quicker.

The pair recently started what’s known as a search fund. It’s a little-known investment vehicle that can give young entrepreneurs the opportunity to buy a company and make their name in the business world without the hassles of getting a startup off the ground.

The concept has been practiced with some success among business school grads from Stanford and a few other elite universities, and is now catching on with a wider swath of investors and entrepreneurs, including Lueck and Tzakis, whose Pylon Capital is among the first such ventures in Los Angeles.

It is still so new, however, that many prospective investors approached by the pair hadn’t heard of the concept.

“Very few people were familiar with it,” said Tzakis, 34. “We did have to do some explaining.”

Search funds, essentially small-scale buyout shops, allow young entrepreneurs without much experience to raise private capital to acquire and take over a company.

Though the investments tend to be small by private-equity standards, the strong returns that search funds can generate has led to a proliferation in the niche. The number of search funds nationwide has ballooned in recent years, while firms such as Pylon and Pacific Generation Partners LLC in Santa Monica have recently brought the concept to the L.A. area.

“I think it’s really starting to spread from the Harvards and Stanfords to other top business schools, such as USC and UCLA,” said Tom Cassutt, managing partner of TD Investment Co., a Pasadena firm that has invested in about 50 search funds since the mid-1990s. “As you have those initial funds out of those schools, that’s likely to attract additional funds over the years.”

‘Lucrative investment’

Search funds are sometimes thought of as starter private-equity firms. At the outset, the principals, typically newly minted business school grads, work their business school contacts to raise about a half-million dollars to fund the search for an established company that they can buy. Once a target is located, the fund principals return to their investors to get additional money to buy the company. Most of the acquisitions have been in the service industry.

The search fund accepts an equity stake and the principals typically take management positions in the company. They work for several years on building the business, then sell and take the profit. A recent study by Stanford’s Center for Entrepreneurial Studies found that search fund investors see average returns above 37 percent. Cassutt said his firm’s returns have been even better.

“It’s been a very lucrative investment,” he said.

The gold standard in the industry is Asurion Corp., a cell phone insurance provider that was bought by a search fund in 1995 for $8 million and sold 12 years later for $4.2 billion.

Of course, there are risks. For the investors, working with young, sometimes inexperienced entrepreneurs means that no return is guaranteed; for search fund founders, entering into a bad deal – or no deal at all – could ruin their reputations before their careers even get started.

The model dates to 1984, when H. Irving Grousbeck, entrepreneur and Stanford professor, came up with the idea.

Lueck said he had heard of search funds as an undergraduate at the University of Virginia, but it wasn’t until he met Tzakis at USC that he gave the idea any serious thought. The two started looking into launching one, but found that there was not much of a network for search fund hopefuls in the L.A. area.

“We had to go out and really learn this on our own,” said Lueck, 32. “Most of the search funds that have been done have been from Stanford or Harvard. They have professors at those schools that can really connect them with other people.”

Still, Lueck and Tzakis met with more than 70 prospective investors, including TD, and raised $525,000 for Pylon’s search phase.

The fund is now looking to buy a company with a strong revenue base and growth potential. It would prefer a company in health care, insurance or environment services, but “no startups, no turnarounds, no retail, no manufacturing and distribution,” Lueck said. The firm has the ability to do a deal of up to $35 million.

Pylon is believed to be the first search fund started out of USC, while Pacific Generation is one of the only known funds started by UCLA alumni. A founder of Pacific Generation said no one at the company would comment for this article.

Rising numbers

The number of search funds is on the rise. As of 2009, according to the Stanford study, there were 41 active search funds in the United States, up from 22 in 2007 and 12 in 2005.

Rich Kelley, a principal and co-founder of Search Fund Partners, a Menlo Park private-equity firm investing in deals sourced through search funds, said the concept is “getting more popular with the entrepreneurial community and it’s getting more popular with the investment community.”

“It’s definitely a little, tiny, specific niche, but it’s growing,” Kelley said.

Since starting his firm nine years ago, he said he has seen a number of business schools begin to incorporate the concept into their curricula and has been fielding more frequent inquiries from new funds looking for capital.

“Since we have been doing this, I’d say the number of searchers that has approached us has quintupled,” he said.